SMALL BUSINESS BORROWERS BILL OF RIGHTS
Frequently Asked
Questions
GENERAL
The goal of the Borrowers’ Bill of Rights is to protect and empower small businesses in accessing credit. 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. 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.
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 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 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.
It applies to loans, lines of credit, merchant cash advances, and similar products, whether or not those credit products are characterized as loans. The term “loan” and related terms used here such as “lending” are intended to be interpreted in the broadest sense possible to include loans, lines of credit, merchant cash advances, and similar products offered and provided to U.S. small businesses, whether or not such credit products are characterized legally or otherwise as loans. Similarly, the terms “lender” and “borrower” are intended to be interpreted in the broadest sense possible so as to include, in the case of lenders, credit marketplaces that facilitate loans on behalf of lenders, cash advance providers, and all manner of persons providing loans to U.S. small businesses or evaluating the creditworthiness of such small businesses in connection with providing a loan, and, in the case of borrowers, all U.S. small businesses who seek or obtain a loan.
Many of the state and federal laws that apply to consumer loans like home loans, student loans, and credit cards do not 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.
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 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.
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.
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.
A network of for-profit and non-profit lenders, brokers and small business advocates, came together to promote responsible innovation in small business lending and combat the rise of predatory and irresponsible lending practices and products they saw in the market. This network created the Small Business Borrowers’ Bill of Rights as a cross-sector consensus that identifies the fundamental rights that all small business owners deserve and all lenders have a responsibility to protect and support. Since its initial release in August 2015 more than 80 institutions have affirmed their support of the Rights as either a signatory or an endorser.
In order to become a signatory of the, a lender, marketplace, or broker must sign an attestation form that affirms they abide by each and every relevant practice set forth in the Small Business Borrowers’ Bill of Rights. There is no option to follow certain practices and ignore others; lenders and brokers sign one standard set of attestations and brokers sign another.1 Organizations that do not provide lending or brokering services, including advocates, trade associations or think tanks, may sign as endorsers of the Small Business Borrowers’ Bill of Rights.
1 For example, the Right to Transparent Pricing and Terms applies to lenders, marketplaces, and brokers, while the Right to Responsible Underwriting applies to lenders and marketplaces but not to brokers.
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 process for becoming a signatory is described here.
There is no option to follow certain practices and ignore others within the Business Borrowers Bill of Rights. Signatories need to abide by the entire Business Borrowers Bill of Rights, as it applies to them with lenders and marketplaces signing one standard set of attestations and brokers signing another.
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.
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. APR and annualized interest rates are standards that allow this comparison.
Other novel forms of expressing the cost of a loan can make loans appear 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 |
|---|---|---|---|---|
$100,000 | 6 Months | 15% | $19,167 | 50% |
$100,000 | 24 months | 15% | $4,791 | 14% |
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.
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 considers 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.
Yes, that is the purpose of annualized rate. Take the example of a car lease. A 1-year car lease may have a lower total cost than a 2-year car lease…
Merchant cash advance providers set loan pricing and terms with a specific repayment period in mind. They must provide an APR using the projected repayment rate.
Dollar cost and monthly payment amount are meaningful only relative to a specific loan amount and loan term. Dollar cost doesn’t allow borrowers to compare costs across different loan amounts or terms, or compare the typical costs of different lenders. APRs describe the cost regardless of loan size and term.
Every term sheet should disclose the APR, the interest rate if one is charged, all scheduled financing charges, 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.
Some loans require that a fixed amount be repaid to the lender, either in full or at a discount, regardless of the actual period in which the loan remained outstanding. If prepayment requires paying financing charges other than those associated with the specific term the financing was 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.
TRANSPARENT PRICING & TERMS
NON-ABUSIVE PRODUCTS
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.
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.
RESPONSIBLE UNDERWRITING
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 monthly 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.
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.
FAIR TREATMENT FROM BROKERS
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.
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.
INCLUSIVE CREDIT ACCESS
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.
