So-called alternative lenders in the small business lending market have been growing exponentially since the financial crash, filling a gap in available credit when traditional lenders cut back on business loans. Yet these alternative lenders often make loans with annual percentage rates (APRs) as high as 135 percent. How could a loan with that much interest actually benefit a small business?
Here are a few reasons why an alternative loan might sometimes make sense:
Bank loans can take months to secure as a result of all the necessary paperwork, proposals and background checks. Sometimes small businesses do not have that kind of time to wait for financing. Alternative lenders typically offer substantial amounts of cash in a matter of days or weeks.
Limited Loan Amount
Many banks today have minimum small business loan limits in the range of $50,000 or even as high as $150,000. This is because originating the loans is so time-consuming and costly to the banks that they only want to loan large amounts of money. Many small firms however do not need that much funding. Alternative lenders offer loans starting at just a few thousand dollars up to about $100,000. When the sum is that small, it is often easier to pay off quickly, limiting the effects of the high APR.
Limited Credit History
In the wake of the financial crisis and the Great Recession, many traditional lenders raised their credit requirements for small business borrowers. This left many startups and fairly young companies – those least likely to have built up a good credit report – unable to obtain bank loans. Credit standards are much laxer with alternative lenders because of the incredibly high-interest rates they charge.
So while business owners should be aware of the risks of high-priced alternative lending, there are certain scenarios where entering into one of these short-term arrangements can truly benefit a small business.