California's legislature recently passed SB 1235, which would make it mandatory for small business lenders to make their rates and terms transparent to borrowers. If signed into law, SB 1235 would make California the first state to demand such transparency.
The new bill fundamentally changes how lenders will operate in California and provides businesses with a better way to shop for loans. Namely, the new legislation can show business owners the true costs of a loan before they sign up for one and agree to any terms. Online business lenders in California would now be required to display:
- The total amount of funds provided
- The total dollar cost of the financing
- The term or estimated term
- The method, frequency and amount of payments
- A description of prepayment policies
- The total cost of the financing expressed as an annualized rate
The bill still needs to be signed into law by California Governor Jerry Brown. The timeline as to when this would happen is still unknown. More than 60 organizations in the Golden State have voiced their support. The news has larger implications, as other states may look to California as an example and follow with similar legislation. Earlier this year, New York State legislates already voiced concerns about the lack of oversight in online lending. This was quickly followed by a decision by the Treasury Department endorsing a national fintech charter, which would allow such lenders to be regulated on a national scale. There are 30.2 million small businesses in the United States and they all stand to be directly affected by this upcoming decision.
Online small business lenders emerged in the wake of banks' hiatus in small business lending after the financial crisis. Banks became more risk averse, and cut back on small loans, from mom-and-pop shops to startups. This created a new market for business loans, and online lenders blew up in popularity to fill the demand. However, while they were willing to issue funds to more risky borrowers, these online lenders were also unclear on the total cost of financing. With the lack of strong regulation, some business lenders were given free rein over how to disclose fees, interest rates and many other crucial terms. Online business lenders also charge significantly higher interest rates than those on consumer loan products. The Opportunity Fund found that business owners in California pay an average APR of 94% for small business loans.
Some lenders fail to ever disclose their rates while others disguise their APRs by calling them different names and framing them to seem cheaper than they are. These are the practices SB 1235 seeks to curb.
One recent report by the Federal Reserve found that "most [small business owners] found the lack of standardization in presentation and the inconsistency of terminology [in online lenders] across the descriptions of product costs and features to be problematic." One owner of a manufacturing business in Colorado said, "It is difficult [to compare when lenders] are using different models and different terminology to try to get our business.”
Businesses don't have the same protections as, say, a consumer borrower. For example, credit card issuers are now required to display all pricing information to borrowers before a consumer submits any private information. This includes information about annual fees, interest rates and foreign transaction fees. Should the California bill set a new standard in lending, small business owners may soon see similar disclosures.