Dory Rand, president of Woodstock Institute, originally shared insights on the terms some online, nonbank lenders offered during the opening plenary of our recent Small Business Finance Forum in Chicago. CDFI Connect caught up with Dory to explore some of the findings from Woodstock Institute's Analysis of Business Loan Terms, and other ways that the Woodstock Institute is working to collect data to help small businesses.Woodstock reviewed of 15 loans issued by 12 lenders. While this sample is not intended to be representative of the broader FinTech marketplace, the 15 loans are similar to those that several CDFIs report seeing in their markets.
During your review of the 15 online loans, what common elements did you find?
The first thing we noticed, across the board, was a lack of transparency regarding the loan terms. You really had to read through the fine print carefully to figure out what all the costs were. As an unregulated space, there is nothing like you see now on a credit card statement, so there is no upfront clear disclosure about an all-in APR, for example. So lack of transparency is a big thing.
Another thing we noticed in all but one of the contracts we reviewed was the abundance of junk fees. We are talking about multiple fees for all kinds of reasons: UCC, filing fees, etc. This padding makes it difficult for the borrower to understand the full cost. Even if they were to disclose a simple interest rate, if you just look at the simple interest rate (say 25%) but then you have five other junk fees—some of which were for $1,000s, and the average was $795—by the time you add that in to the all-in APR, the cost is drastically different.
Another common theme we saw was a pre-payment penalty. These penalties really discourage people from paying back their loans ahead of schedule, so it’s a way of prolonging the debt trap.
Of the loans you looked at, what was the average length?
The terms varied considerably, from several months to over a year. But one thing we saw was that for all loans under 200 days, the effective interest rates were over 100%. We found lower effective APRs only in the much longer term loans.
How are they hiding the fees?
There is no upfront disclosure of an all-in effective APR rate. That’s the easiest way to disclose costs to borrowers who want to be able to comparison shop. If you have simple interest plus a laundry list of fees, there is no way to compare. There is currently no requirement for non-bank FinTech lenders to disclose an all-in APR, but some members of the industry are starting to embrace it.
What parallels are you noticing in the predatory lending space between consumers and small business borrowers?
The online loans we analyzed are the small business equivalent of payday loans and toxic mortgage loans to consumers. There are so many similarities: high interest rates; prepayment penalties; and, a system that does not make loans based on ability to repay. The way these loans are structured provides lenders with direct access to the company bank account—they have ensured their ability to collect, mostly by doing daily draws from the bank account. No matter what is going on with that business, no matter what other expenses they have, that lender is getting first dibs and taking that money out in a way that can be harmful to the borrower.
Another similarity is that when a segment of the lending industry is unregulated, and there is no requirement that lenders report to some kind of centralized database, borrowers can get stacked in debt in multiple loans. They take out a new loan to make the payments on their other loans. The end result can be that a borrower can have five or more loans out at the same time, which leads to similar cases of people stuck in debt traps.
To do a real ability to repay analysis, you have to not only determine whether the borrower can repay that specific loan, but also determine whether the borrower can keep up with existing obligations and other debts. These determinations are currently not made in the FinTech small business lending market.
What led you to explore these types of loans?
For quite some time we have been working with the [Chicago] Mayor’s office, Accion Chicago, and the Responsible Lending Coalition to try to come up with solutions around non-traditional/FinTech small business lending. The CDFI world and the City of Chicago were both seeing bad impacts from these loans. Our initial research report in 2014—Dis-Credited: Disparate Access to Credit for Businesses in the Chicago Six County Region—was focused on traditional lenders and banks, but we heard from the community and the city about these non-bank loans that are really hurting people in and outside of Chicago. We started to see this was a significant problem because it brought up parallels to payday loans and predatory mortgage lending, which caused the financial crisis in 2008. We couldn’t ignore it and be late to the game again, like we were with the mortgage crisis. We wanted to get a handle on it before it totally comes apart.
Tell us about your work with the Consumer Financial Protection Bureau (CFPB) around small business lending:
Right now, no agency is collecting data on small business lending by non-banks. As a result, among other things, we don’t know if people in low-and moderate-income neighborhoods have equal access to these non-bank loans. So we don’t know, for instance, if there are fair lending violations. Gaining access to this data is so important to understanding accurately what is going on with interest rates and fees, and the individuals who are impacted. The Equal Credit Opportunity Act applies to small business loans.
Another thing we don’t know at this point is how the proprietary algorithms around credit scoring are affecting people. There is a lot of talk about new ways of determining credit worthiness and, because it is proprietary, we can’t tell whether these methods might be hurting certain categories of people. The disparate impact doctrine is still alive and well.
Fortunately, the Dodd-Frank Act section 1071 gave authority to the CFPB to issue new small business lending data collection rules. CFPB is in the early stages, starting by hiring Grady Hedgespeth to lead its Office of Small Business Lending and the initiative around small business data collection. We are pleased to see small business data collection on the rulemaking agenda for this year, and we look forward to working with CFPB on it. We have a lot of experience from the Home Mortgage Disclosure Act (HMDA) side of things and participated in some beta testing of CFPB’s new HMDA data portal. Our experience in working with HMDA data will help us as we advocate with the Bureau on small business lending and, hopefully, we will get to do beta testing on this.
What solutions do you see so far, and what solutions are you advocating for?
We believe that there is a need for both data collection from, and regulation of, the non-bank FinTech lenders to level the playing field, promote competition and comparison shopping, and protect vulnerable borrowers. We are advocating for clear disclosures of costs (including an all-in APR), ability to repay standards to avoid debt traps, and limits on excessive fees. We are not convinced that federal prudential regulators should create a new banking charter for FinTech lenders. While we are waiting for developments at the federal level, we believe that states may provide some solutions in this new arena. For example, we support Illinois Senate Bill 2865, which would for the first time require licensing of non-bank small business lenders, establish an ability to repay determination, and enforce some limits on prepayment penalties. It wouldn’t cap fees, but it would require use of a database to submit evidence that borrowers are eligible and to prevent debt traps. We worked very closely with City Treasurer Kurt Summers, State Sen. Jackie Collins, and Accion Chicago in developing that bill. If we succeed, Illinois could be the first state in the country to enact such policies.
Due to industry opposition, it’s an uphill fight to ensure access to safe and responsible small business credit.