The capital and credit access challenges facing many business owners in today’s turbulent inflationary environment mean that some may pursue questionable financing options offered by unscrupulous parties in the form of predatory lending. Jason Keller and Emily Redig of Wolters Kluwer look at the factors that can lead to predatory practices and how to mitigate those risks to foster compliant, fair lending.
As small-business owners feel the pinch of high costs, inflation and a potential recession, more are increasingly turning to financing. Yet the financing options that are available can pose risks to business owners who fall prey to predatory financing arrangements. How can small-business owners get the financing they need but avoid stepping into a predatory lending situation?
As the U.S. continues to deal with inflation, small businesses play a key role in the communities they serve — as employers, as stewards of regional commerce and as staples of economic development. To meet these objectives and deal with rising costs, small businesses need access to affordable and reliable capital.
During economic times like these, the small-business ecosystem can become stressed as business owners and entrepreneurs face pressures stemming from increases in their own costs of goods, increases in rental and other fixed expenses such as utilities and the ever-present uncertainties in the labor market. Financing remains available to well-qualified small-business owners, but lenders may be tightening their lending standards due to recessionary concerns, which could reduce access to credit.
Such challenges create opportunities for unscrupulous actors to step in and provide short-term borrowing solutions with expensive and unreasonable terms or unrealistic options for repayment, otherwise known as predatory lending.
That said, banks and credit unions remain critically important in ensuring credit and capital needs are safely and soundly met. In periods of inflation and potentially stressed economic times, regulated lenders must be mindful of fair-lending laws and regulations that are, in part, intended to prevent predatory lending. In adhering to those laws and regulations, banks and credit unions must remain diligent in their underwriting and pricing practices to ensure dollars are lent fairly and equitably, with the borrower’s best interest in mind.
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Because of federal and state regulatory oversight, as well as pressures from community leaders, researchers, and philanthropists, dollars lent through banks, credit unions and community development financial institutions (CDFIs) can curb predatory lending practices. Predatory lenders, by definition, prey on small-business owners who feel that they have few to no options to sustain or grow their operations.
Generally speaking, the process of making a borrowing decision and weighing the pros and cons of entering into a loan can be stressful enough, but at-risk or financially unstable entrepreneurs may find themselves in an elevated state of vulnerability, opening themselves up to be taken advantage of by predatory lenders.
To assist in steering clear of predatory lenders, borrowers should consider the following action steps:
Do your research: While almost all lenders will do their best to sway borrowers from shopping around, spending time comparing interest rates and terms from a few lenders will likely prove to be worthwhile time spent. Doing so will allow borrowers to better understand what terms and conditions should be expected by reputable lenders in the market within a given period, while also exposing overpriced, potentially predatory lenders in the process.
Read and be sure to understand contractual agreements: Predatory lenders have made a livelihood out of perfecting the art of the bait and switch. Read the small print. Ensure terms discussed during the application process, particularly those over the phone or in person, are in agreement with the contract you are signing. Ask questions and seek guidance from outside sources if there is anything you do not understand, or feel is unclear.
In 2023, regulated lenders are still scoring loan applications based on the 5 Cs of credit — capacity, capital, collateral, character and conditions. While it should go without saying, a sixth element of accessing credit should include a focus on compliance, as lenders work to identify and execute opportunities that provide business owners sound access to credit and capital.
Although periods of higher inflation constitute a condition factored under this test, if considered appropriately, business owners can still manage the challenges of today’s market and borrow from regulated lenders and remain economically solvent. Vigilance remains the watchword, both for lenders as well as small-business borrowers with whom they collaborate.