Protect Your Business: 5 Warning Signs of Predatory Loans
One of the most important parts of running a business is securing appropriate funding.
The unfortunate reality is that there are predatory loan products waiting to take advantage of unsuspecting entrepreneurs. In this blog post, we will explore the five warning signs that can help you spot predatory loan products and protect your business from their detrimental effects.
What are predatory loans?
Predatory loans are deceptive loan products designed to exploit borrowers and place them in a cycle of debt. These loans often come with exorbitant interest rates, hidden fees, unfair terms, aggressive marketing tactics, and a lack of transparency. They can have severe consequences for individuals and small businesses, leading to financial instability and even bankruptcy.
Warning Sign 1: Excessive interest rates
High-interest rates are an unnegotiable red flag for any loan product and can quickly become a burden for small businesses. It is common practice for predatory lenders to offer loans with interest rates well above the market average, often nearing 1000% APR. To identify excessive rates, compare them to a variety of other lenders.
For reference, in December of 2022, the Federal Reserve Bank of Kansas City estimated the average interest rate for small business term loans was 6.4% for fixed-term loans and 7.4% for variable-term loans. While not every small business owner will be able to access loans with this interest rate, this should act as a good reference point for any small business owner looking to borrow capital.
Warning Sign 2: Hidden fees and charges
Predatory loans are notorious for hidden fees and additional charges within their terms. These fees can include application fees, origination fees, prepayment penalties, insurance, and more. To protect your business, consult a financial professional, carefully read the fine print, and pay attention to any ambiguous language. Uncovering hidden charges will help you make an informed decision about the true cost of the loan.
To easily view all the costs of a loan as a percentage of the amount you are borrowing, be sure to look at a loan’s Annual Percentage Rate (APR).
Warning Sign 3: Unfair and deceptive terms
Predatory lenders often include unfair terms and conditions in their loan agreements. These terms can include ambiguous clauses, balloon payments, and unreasonable collateral requirements.
It's crucial to understand what you're agreeing to and analyze the loan agreement for fairness. Look out for deceptive loan terms that could trap your business in a cycle of debt. If you’re concerned or confused about something, consult a financial professional.
Warning Sign 4: Pressure tactics and aggressive marketing
Predatory lenders employ aggressive sales techniques to create a sense of urgency to pressure borrowers into making hasty decisions. These tactics can include high-pressure sales calls, limited-time offers, and false promises of guaranteed approval.
No one should ever be pressured into borrowing money, especially when considering the high stakes for one’s livelihood. Recognizing these tactics will help you to steer clear of high-pressure loan offers and protect your business from their negative consequences.
Warning Sign 5: Lack of transparency and disclosure
Transparency is vital when it comes to loan transactions. Predatory lenders often lack transparency in their practices. Be wary of lenders who are unwilling to provide clear and comprehensive information about their loan terms, conditions, and fees.
Use resources and online tools to verify the credibility and legitimacy of lenders before entering into any loan agreement. The Consumer Finance Protection Bureau (CFPB) and your state’s Attorney General are good starting points to find out if your lender is credible and to find any past infractions.
By being aware of the warning signs of predatory loan products, entrepreneurs can shield their businesses from potential financial ruin.
Excessive interest rates, hidden fees, unfair terms, aggressive marketing tactics, and a lack of transparency are all red flags to watch out for. Stay vigilant, exercise due diligence, and empower yourself with the knowledge to make informed financial decisions that protect the longevity and success of your business..
Consult a financial professional at one of Kansas City’s many CDFIs if you have more questions.