Frequently Asked Questions
Why was the Small Business Borrowers’ Bill of Rights developed?
The Borrowers’ Bill of Rights was developed by a broad coalition of nonprofit and for-profit lenders, credit marketplaces, brokers, and small business advocates, with great hope for the ways that innovation is increasing access to affordable capital, but with growing concerns about the rise of predatory small business lending practices. The Borrowers’ Bill of Rights was developed to protect and empower small businesses in accessing credit. It represents the first consensus on responsible business lending practices, and we encourage everyone in the small business lending industry to join us and support the Borrowers’ Bill of Rights as an Endorser or a Signatory.
What abusive lending practices are you concerned about?
Here are some of the practices that the Borrowers’ Bill of Rights seeks to address:
- High Cost – Although borrowers may not realize it, it is common for some business financing products to carry an equivalent annualized interest rate of more than 50% or even 100%.
- Lack of Transparency – Loans are commonly offered with confusing or misleading pricing information. Often no interest rate is disclosed. Instead, pricing may be quoted to a borrower in a “rate” that is not a true interest rate. For example, a borrower’s 20% “rate” may actually be equivalent to an interest rate of 55% or more.
- Prepayment Cost – Some lenders charge a fixed repayment amount, and it is not possible for borrowers to save money by prepaying, as they would with a traditional loan. This is not always transparently disclosed.
- Debt Traps – A debt-trap may develop when a borrower takes out a loan in an effort to repay another loan, generating new fees for the lender and a greater debt burden for the borrower. This dynamic can develop because of the high repayment burden required by expensive or short-term loans, and a lack of appropriate underwriting scrutiny to ensure the borrowers can in fact afford to repay the financing.
- Double Dipping – Borrowers stuck in debt traps may become highly profitable for some lenders through a practice commonly referred to as “double-dipping.” Double-dipping may occur when a lender refinances a loan it previously made to a borrower and charges a new fee on the entire amount of the new loan, including the portion being refinanced. This practice results in the lender double-charging the borrower on the portion of the loan outstanding at the time of the refinance.
- Stacking – Borrowers sometimes receive multiple cash advances “stacked” on top of each other, each diverting a percentage of sales from reaching the business. For example, if two merchant cash advance providers are each diverting 10% of a business’ gross sales, and the business’ profit margin is below 20%, the business will likely be unable to remain profitable or even stay in business.
- Broker Abuses – Referral fees paid to brokers may be as high as 12% of the loan amount, leading some brokers to steer borrowers toward the loans or lenders where the broker stands to profit most, rather than to the loan or lender that serves the best interests of the borrower.
What types of financing does the Borrowers’ Bill of Rights apply to?
It applies to loans, lines of credit, merchant cash advances, and similar products, whether or not those credit products are characterized as loans.
Isn’t there already a lot of regulation governing business lending?
There is not. You may be surprised that many of the state and federal laws that apply to consumer loans like home loans, student loans, and credit cards don’t apply to small business loans. Without those protections or a federal regulator of small business lending, we believe the Borrower’s Bill of Rights is a critical step to address problems in the small business lending industry. It is intended to serve as a standard of industry-wide responsible lending practices so that we, as an industry, can hold ourselves accountable for shining a light on misleading, confusing, and predatory lending practices. We strongly believe that all small business owners deserve each of these basic rights.
Can't business owners make the best decisions for themselves?
Yes, and the key to making good decisions is having objective and comparable information. Many small business owners are experts in their fields, but not experts in all of the financing products that are available. The goal of the Borrowers’ Bill of Rights is to ensure that small business owners receive the information they need to make informed borrowing decisions on behalf of their small businesses, and to discourage practices that have commonly steered borrowers into loans they cannot afford or with onerous terms which do not allow them to operate, let alone grow.
How do banks fit in?
Many banks have engaged in responsible business lending for a very long time. We encourage these banks, and other traditional and alternative small business lenders, to stand for responsible business lending by becoming signatories to the Borrowers’ Bill of Rights.
Don’t some lenders who do not abide by the practices in the Borrower’s Bill of Rights actually help businesses by funding businesses other lenders do not?
All businesses deserve credit products that are transparent and not abusive. Targeting lower-credit small businesses with products that are not transparent, have abusive features, or can lead to debt traps is not the right way to serve those businesses.
How did the coalition decide which organizations would participate in establishing the Borrowers’ Bill of Rights?
The nonprofit and for-profit lenders, brokers, credit marketplaces, and small business advocates established the Borrowers’ Bill of Rights came together through writing or speaking about the need to establish responsible business lending practices, and found they shared a set of values on responsible business lending. The Borrower’s Bill of Rights is open to all small business financing providers who abide by the rights, and we encourage everyone to join.
How will you ensure accountability among organizations who sign the Borrowers’ Bill of Rights?
To become a signatory, we require an organization’s chief executive to sign a detailed Attestation stating that his or her organization abides by each of the practices set forth in the Borrowers’ Bill of Rights. The signed Attestations are posted here, and the process is for becoming a signatory is described here. We believe that a chief executive will refrain from making a public record of his or her organization’s compliance with these practices if his or her organization does not actually do so. We view this attestation process as a first step. We intend to continue to use our best efforts to promote transparency and responsible business practices for small business lending.
How is an interest rate or an APR calculated?
Annualized interest rate is defined as the scheduled or periodic financing costs, expressed as a percentage of outstanding principal, and annualized. Interest rate does not include upfront costs charged to the borrower, such as fees related to origination, processing, or closing (although these costs must also be fully disclosed). It does include periodic costs charged to the borrower, such as monthly fees. For a rate to be referred to as an “APR” or “Annual Percentage Rate”, the rate must equal the total annualized cost of the financing, including scheduled financing costs as well as all such upfront costs.
If a rate is promotional or introductory, the term sheet should clearly state that the rate is subject to change and how the rate could change. If the loan does not amortize over its term, an equivalent annualized interest rate or APR should be calculated and disclosed. We believe that referring to other methods of calculating the cost of a loan as an interest rate, or simply as a “rate,” is likely to mislead a small business owner.
For lines of credit or other open-ended types of financing, APR must include all upfront and anticipated fees, and be calculated with reasonable assumptions about use including assuming that the borrower draws the full amount on the origination date, and makes the minimum payments required.
Why isn’t it sufficient to quote pricing as a “percent of the loan amount,” “factor rate,” or another novel type of rate, instead of annualized interest rate or APR?
In order to make informed borrowing decisions, small business owners need pricing quoted in way that allows them to understand and compare their loan options. Annualized interest rates and APRs are standards that allow this comparison.
Other novel forms of expressing the cost of a loan can make loans appear far less expensive than they actually are, and can be easily mistaken for interest rates. For example, the chart below shows how loans with quoted costs of “15% of the loan amount” may actually have an interest rate of 50% -- an easy but very costly mistake for a small business owner to make. Additionally, while quoting pricing as “15% of the loan amount” may reflect the total cost of a loan, it does not describe the financing effect on the borrowers’ cash flow. Take this example in the chart below:
|Loan Amount||Loan Term||“Percent of the loan amount” or “factor rate”||Monthly Payment Amount||Annualized Interest Rate|
The “percent of the loan amount” doesn’t give any indication of the big difference in monthly payment between a 6-month and 24-month term. Interest rate relates to both the total and periodic cost of a loan. Lower total cost and lower periodic cost both correspond to lower interest rates.
If the term of a loan is shorter than one year, why should the rate be annualized?
The rate should be annualized so that small business owners can effectively compare a loan offer with other loan options. An annualized rate is also helpful for small business owners to manage their cash flows because it takes into account the rate of repayment required by a loan. Faster repayment corresponds to a higher annualized interest rate, reflecting higher monthly repayments owed by the borrower. Additionally, short-term lenders often encourage borrowers to re-borrow or renew their loans, and may even advertise these renewal rates as a sign of customer satisfaction. So a short-term loan often becomes a medium- or long-term series of related loans to the same borrower. The borrower may never be informed of the true cost of such loans, taken together, even where an annualized rate would have been appropriate.
How can an interest rate be calculated for cash advances, which don't technically charge interest?
Merchant cash advance providers set loan pricing and terms with a specific repayment period in mind. They must provide an estimated annualized interest rate or APR using the projected repayment rate.
Why is an interest rate needed if borrowers are told the dollar cost of the loan? Isn’t that what really matters?
Dollar cost and monthly payment amount are meaningful only relative to a specific loan amount. Dollar cost doesn’t allow borrowers to compare costs across different loan amounts, or compare the typical costs of different lenders. Interest rate describes the cost regardless of loan size.
Is APR the best way to provide comparable loan pricing information? Should the small business lending industry unite around APR as the standard rate disclosure?
Yes. APR is the best standard for expressing the total and periodic cost of a loan, but it’s still uncommon among both traditional banks and non-bank business lenders. We believe that making annualized interest rates a minimum standard of pricing transparency in small business lending, together with disclosing all scheduled financing costs, is a huge step forward for borrowers, who now struggle to make apples-to-apples comparisons between pricing shown in “factor rates,” “cents on the dollar,” “percent of the loan amount,” “payment multipliers,” and other novel forms of rate. Although we focused on addressing transparent pricing issues in a way that responsible bank and non-bank lenders can currently support, we would urge the small business lending industry to raise the standard for transparent pricing to APR.
What charges should be disclosed in a term sheet?
Every term sheet should disclose the annualized interest rate or APR, all scheduled financing costs, the loan amount, payment amount and frequency, collateral requirements, and the cost of prepayment. Costs that are not charged to the borrower or that may not be incurred, such as late fees, are not required to be disclosed on the term sheet but must be made clear to the borrower before they accept a loan.
How should the effect of prepayment be disclosed?
Some loans require that a fixed amount be repaid to the lender, either in full or at a discount, regardless of the actual period of time in which the loan remained outstanding. If prepayment requires paying financing charges other than those associated with the specific term the financing was actually used for, the lender must disclose these financing charges as a prepayment penalty or fee. If the loan does not amortize and a fixed repayment amount is required, even if discounted, we believe it is deceptive to claim to a borrower that the loan has no prepayment penalty. At the time of payoff, if a fixed repayment amount will be charged, with or without a discount, the remaining contractual payments should be disclosed upfront as a prepayment penalty or fee.
What is "double dipping"?
A: Borrowers stuck in debt traps may become highly profitable for some lenders through a practice commonly referred to as “double-dipping.” When borrowers take out new loans before fully repaying an existing loan, they are often double-charged for the outstanding portion of their loans, although many may not realize it. For example, a borrower who still owes $20,000 may take out a second loan of $50,000. The $20,000 they owe would be rolled into the new loan or required to be paid off first, and so they receive only $30,000 of new capital rather than $50,000. However, they may be charged financing costs on the full $50,000, which would in effect mean they were double-charged for any new charges relating to the $20,000 that had been outstanding.
When can a lender charge a fee in refinancing a loan that it previously made?
A: In refinancing a loan, fixed charges should be assessed only on new capital provided to the borrower, except in a loan workout situation. In that case, where a troubled borrower is provided a lower payment, longer repayment terms, or other similar assistance, reasonable fees may be charged to cover costs incurred by the lender associated with the loan workout.
Why should loans repaid through gross sales require a higher standard of verifying ability to repay? What is the standard for that verification?
Lenders who receive repayment through credit card processing or daily ACH receive payment directly from sales and, as a result, the lender gets paid before the borrower does. This approach has advantages, but may result in lenders not sharing the borrowers’ interests in financing only what the borrower can truly afford to repay. Lenders using these repayment methods should verify that the borrower can in fact afford all financing payments and major expenses and remain profitable through documents, data from third parties, and/or due diligence. If the borrower is unable to repay a loan while remaining profitable, the lender should make the loan only if due diligence indicates that the borrower has a credible path to profitability. Lenders repaid on a monthly basis should also conduct detailed due diligence. Because they are paid after the borrower has the opportunity to apply revenue to other expenses, these lenders share the risk of business unprofitability with the borrower, and have a strong incentive to lend only what the borrower can afford to repay.
How should lenders report to credit bureaus?
Lenders should report loan information to the major credit bureaus, including balances, dates, and payment activity, from the beginning of the borrower’s obligation. If loans will be reported to a consumer credit bureau in respect of a guarantor only after a default by the borrower, the guarantor should be clearly informed. We recommend that loans to businesses whose owners have limited or weak personal credit history be reported to the consumer credit bureaus, to help those small business owners improve their credit scores and access lower-cost financing in the future.
Who is considered a broker?
A: A broker is an intermediary whose primary purpose is to connect credit seekers with financing options from multiple companies, and provide guidance on those finance options.
Do brokers who abide by the Borrowers’ Bill of Rights refer borrowers to lenders who may not abide by these rights?
A: They may. Sometimes, better loan options may not be available to a borrower. If referring a borrower to a lender that does not abide by these rights, responsible brokers advise borrowers of the risks of harm, such as debt traps or double-dipping, provide borrowers the actual interest rate, and indicate that rates shown by the lender may not be an annualized interest rate. Ideally, better, more transparent loan options without dangerous features will become available.
Are gender identity and sexual orientation protected by existing regulations from discrimination in lending?
In most states, Lesbian, Gay, Bisexual and Transgender (LGBT) individuals are not legally protected from discrimination. Only ten states and the District of Columbia have enacted credit nondiscrimination laws covering sexual orientation and gender identity, and no federal law applies. We urge the small business lending industry to extend fair lending principles to cover gender identity and sexual orientation for small business owners.