Fintech Transparency in Small Business Lending — Diane Paterson

Summary

Diane Paterson, director of the Twin Cities Small Business Development Center, hosted by the University of St. Thomas, gives written testimony to the Small Business Committee's Subcommittee on Oversight, Investigations and Regulations on fintech lending. She says fintech rates quoted as 3.5%-4.5% are calculated on a daily basis, producing an interest rate in the range of 58-63%. She cites a client brewery that took a $100,000 loan from OnDeck at 58.6% with a twelve-month term and monthly debt service of $11,208.00, after its bank refused a second loan. She says the bank ultimately chose to refinance the fintech loan, and she calls for strong guidelines driving uniformity in fintech lending practices.

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Full text

                                     Small Business Committee
                   Subcommittee on Oversight, Investigations and Regulations
                         Fintech Transparency in Small Business Lending


Good Morning Committee Members. It is an honor to testify today at this hearing. My name is
Diane Paterson and I am the Reginal Director of the Twin Cities Small Business Development
Center, hosted by the University of St. Thomas.
With today’s online credit lending environment, where many Fintech services offer a four-
minute application and 24-hour turnaround to access funds, the SBDC is seeing small business
owners navigating confusing fine print, adverse interest rates, loan terms, and early pay back
penalties that have the power to put them out of business.
These lending practices are especially harmful to small, young, less profitable, and minority-
owned businesses, who already struggle to access financing because they lack the business
history or collateral that traditional banks require. Yes, the ease and speed with which small
business borrowers can access Fintech credit is appealing and even beneficial. But these
businesses tend to use this loan option in conjunction with other forms of credit, making them
financially vulnerable.
The application process for a traditional lender takes days. The approval process itself can take
weeks, or longer depending on the meeting schedule of the loan committee. Standing in stark
contrast, two Fintech options- Biz2 Credit and Blue Line, advertise four- and five-minute
completion times respectively. Both promise next-day availability of funds. While Fintech loans
address pain points in the loan application process, these loans subject borrowers to much
higher interest rates and other terms that cause many to default.
The biggest issue in Fintech lending practices is the lack of transparency in the price of their
products. As consumers, we are accustomed to seeing rates of 3.5% to 4.5%, APR. This
commonly understood Annual Percentage Rate terminology is familiar- it makes sense. Fintech
borrowers READ rates ranging from 3.5%-4.5%, and assume they are APR. What they do not
realize is that the Fintech rates are regularly calculated on a DAILY basis. This results in a
lending relationship that subjects the borrower to an interest rate in the range of 58-63%.
Simply put, Fintech’s lending practices are an issue, with this daily calculation the first of several
fine print problems.
Kabbage for example, advertises a “Loan Fee” instead of an interest rate. OnDeck’s interest
rates are clear, but they range from 24.6%-58.5%. Lending Club, charges 9.77%-35.71% interest,
and then assigns an additional loan Origination Fee, ranging from 1.99%-8.99%.
The cost of Fintech credit is high. The terminology is confusing. Adding more fuel to the fire, the
repayment terms of many Fintech loans are becoming problematic for borrowers. Fintech loan
repayment terms are traditionally very short- six-twelve months in most cases. This greatly
impacts the level of the borrower’s monthly debt service. While many Fintech lenders offer
weekly installments, this doesn’t change the reality that these payments are often too large for
a small business’ cash flow to digest.
To illustrate, a client of the Small Business Development Center founded a craft brewery
operation making gluten-free beer. Due to the nature of their product, they were unable to
brew beer using another craft brewer’s equipment during the startup phase. As such they
financed “new” machinery using a $375,000 loan from a bank. The taproom was an instant
revenue generator, but their revenue from distribution lagged behind their projections.
They approached their bank for a second loan for $100,000 to cover working capital, to bridge
until the distribution side of the business caught up, but the application was rejected. The
brewery had no choice but to seek a $100,000 loan with OnDeck, thinking the interest rate was
comparable, or lower, than the bank. The interest rate in reality was 58.6%, with the term of
the loan only twelve months. The debt service (principle and interest) payable per month was
$11,208.00.
Our office intervened on behalf of our client and asked the original bank to reconsider. The
bank initially refused because the $100,000 loan was also subject to a $20,000 pre-payment
penalty, pushing the principle owed to $120,000. We worked with the bank to help them
understand that without their help, the brewery would likely default on the bank’s original loan
PLUS the Fintech financing. To ensure the viability of the company, the bank ultimately chose to
refinance the Fintech loan. While very positive, this outcome is rare- most businesses would
have no choice but to default.
Strong guidelines driving uniformity in Fintech lending practices and fine print language, clearly
focused on the borrower’s ability to repay, will give consumers the ability to compare loan
options apples to apples, and reduce the number of borrowers who default. With new business
startups at an all-time high, now is the time to address this issue.


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