Fintech lending has expanded in recent years, disrupting the small business lending market by leveraging AI technology and data analytics.
While fintech lenders bring a number of advantages to small businesses, namely enabling them to borrow money quickly and efficiently when traditional borrowing from banks hasn’t been the easiest of tasks, it is not without its challenges.
Small businesses should be aware of some of the issues that can arise when borrowing from fintech companies.
Congressman Worries Fintech Lending May Be Hurting Small Business
To shed light on the challenges, Hon. Dean Phillips, a member of the House of Representatives, issued a statement of fintech and transparency in small business lending.
Phillips expressed concern that fintech lenders may be taking advantage of small businesses and the self-employed.
He notes how during the Paycheck Protection Program, the Committee on Small Business witnessed how developments in technology, aka fintech, were making small-dollar PPP loans to small business, especially those in underserved communities, more effectively than traditional banks.
The congressman continues that while fintech lending had helped many entrepreneurs, concerns are escalating that industry practices may target and harm small businesses.
Lending Terms Not Always Clear
Terms are not always clear to small businesses says Phillips, with many online lenders providing little or no information upfront to prospective borrowers about the loan or product.
“For instance, the speed at which fintech lenders deploy capital can come at a substantial cost. A conventional bank loan typically carries an APR of 4 to 13 percent. For Fintechs, APR for online loans and other financing products can start at 7 and climb higher than 100%,” he warns.
The Congressman also warns of the predatory practices some fintech lenders can use that puts small businesses at risk. He alludes to how Merchant Cash Advances enable lenders to receive a fixed percentage of future sales until the financing is repaid.
“The extremely high-interest rates and daily repayments associated with MCAs can cause businesses to enter into an out-of-control debt spiral,” says Phillips.
The member of the House of Representatives also notes how many MCA lenders require borrowers to sign an obscure legal instrument to obtain the money. “By signing, borrowers waive their legal rights regarding any legal dispute that might arise,” he says.
Confession of Judgement
The legal instrument is known as a confession of judgement to get the money. According to Dean Phillips, when a court enforces the confession of judgement, it locks a small company into “that unsustainable debt cycle and ultimately forces them to close.”
The lack of transparency around fintech underwriting is another concern for small business advocates says Phillips. Data and algorithms that control automatic underwriting can pull unrelated information such as who an applicant follows on social media or the number of criminal records in an applicant’s zip code.
“These underwriting practices lack transparency and have the potential to unfairly deny credit to protected groups or make those products more expensive,” says Phillips.
Dean Phillips concludes the statement by urging Congress to keep pace and make sure industry practices are not unfairly exploiting entrepreneurs, as the fintech sector grows.
It is important small businesses looking to borrow money are mindful of the exploitative practices of some fintech lenders and do sufficient research and take legal advice before committing to taking on loans.
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