A recent survey of small businesses by Lendio, a platform that matches small business borrowers with lenders, has revealed that when evaluating the cost of a loan, the total payback amount plays a crucial role in the decision-making process. While annual percentage rates (APRs) are obviously important, small business owners are equally, if not more, concerned with the total amount that they will have to repay.
In fact, if given a choice between using the APR and the total payback amount, borrowers would prefer to use the latter to decide which loan to choose.
Many online lenders do not disclose the APR and small business borrowers are often ignorant of the true cost of the loans that they are taking. This has earned the alternative lending industry a reputation for charging high-interest rates while deliberately not revealing what a loan costs. Regulatory authorities in several states, including California, New York, and Illinois have called for a greater degree of monitoring of the activities of online lenders.
Industry analysts and experts are of the view that lenders should be required to reveal APRs much in the same manner as banks and other financial institutions are mandated to inform consumers about the interest rates being levied on them.
But Lendio’s survey reveals that business owners do not consider the APR on a loan to be the best metric available to them. Writing in Forbes, Brock Blake, CEO of Lendio, explains, “We were skeptical about the “apples to apples” comparison because APR may not give business owners a realistic picture of cost for loan products with terms shorter than a year.”
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In an effort to determine how small business borrowers arrived at a decision, Lendio’s survey presented details of a hypothetical loan in several different formats. Two-thirds of the respondents said that when information about the loan included the total amount that they were required to pay back, they found it easy to take a borrowing decision.
“These survey results tell us how the cost of capital is expressed has a dramatic impact on whether or not the borrower takes a loan. I thought it was especially interesting that small businesses are less likely to take a loan when the cost of the loan is expressed as an APR (vs. a factor rate or total payback amount) even when that loan might be accretive to their financial success,” says Brock Blake.
The online lending industry has realized that small business owners do not only consider APR when deciding whether to take a loan. Consequently, industry leaders, OnDeck, Kabbage, and CAN Capital have come together to launch the Innovative Lending Platform Association, which will, among other initiatives, create SMART, a model that will offer small businesses standardized pricing comparison tools.
Straightforward Metrics Around Rate and Total Cost (SMART) is currently in its “national engagement period”, and a time of 90 days has been provided to lenders, trade associations, policymakers and non-profit organizations to give feedback. The rationale behind the SMART Box hinges on providing small business borrowers with a comparison of total dollar cost as well as APRs.
If the Innovative Lending Platform Association can convince a majority of online lenders to adopt a more transparent pricing policy, small business borrowers can gain immense benefits.
It is quite clear that interest rates are not the single most important factor for small business owners. The online lending industry would do well to put into practice what Brock Blake says, “Let’s not make APR a “third rail” for lenders. Instead, as an industry, let’s come together and commit to providing small business owners ALL relevant information they need to make solid financial decisions.”
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