Getting a bank loan for your small business can be challenging. Though the number of approvals has been increasing in recent years, new companies are often not considered due to their lack of financial history. Even if you meet rigorous credit and cash flow standards and revenue minimums, the whole loan process still requires time and energy.
To avoid the hassle of securing conventional financing, businesses often turn to alternative lenders – non-institutional companies that provide smaller, faster loans to business owners. If you’re considering going the alternative lending route, it’s essential to understand some of these lending sources’ downsides and red flags.
The term “alternative lending” refers to a broad range of loan options outside conventional bank loans. According to the December 2021 Biz2Credit Small Business Lending Index, the approval rate for alternative loans was about 26%, while the rate for big-bank loan approvals sat at 14.3%. (These approval rates are lower than in the past due to a COVID-related slowdown in small business lending; approval rates are expected to rise.)
Alternative lenders also have the advantage of funding in days rather than weeks or months.
With a better chance of getting a loan and fast funding, alternative lending can seem too good to be true – and it could very well be if you don’t choose your lender carefully.
“Not all loans are the same,” said Jordan Niefeld, CPA and certified financial planner with Raymond James & Associates. “Institutions make money by lending, and [borrowers could have] expensive bills and rack up interest because they didn’t do their homework.”
If you want to ensure you’re signing with a reputable organization, here are six red flags to watch out for when evaluating potential alternative lenders.
Fundamental internet safety means never sending sensitive personal and financial information through an unsecured website. Hunter Stunzi, founder of Advisor.com, told us that a site without a valid SSL certificate – which certifies that private information is transferred securely – is likely out to steal your information.
In the alternative lender’s website navigation bar, you should see “https” in the URL, along with a lock icon. This is a quick way to see if a site is secure, Stunzi explained, also advising that prospective borrowers check the site through a program like Norton Safe Web to ensure it’s registered to a verified business.
If you can’t find this information, you may be unwittingly consenting to your personal data being sold to third parties, resulting in unnecessary and potentially harmful credit inquiries.
One of the crucial considerations when trying to secure a loan is knowing whether or not you can pay it back. A loan’s terms and amortization schedule will break down how interest accrues, what percentage of your payment goes toward interest and whether there are other fees associated with the loan.
Niefeld said that a reputable lender should be able to give you this information and thoroughly explain what your loan is going to cost you over time, especially if you’re late with payments or you miss payments.
“A lender or broker who is unwilling to disclose and define fees [is a red flag],” added Jim Salters, co-founder and chairman of Quanta HCM. “You absolutely have the right to understand what you’re paying and why you’re paying it. If you feel your requests are being ignored or glazed over, I would find a new lending partner.”
Any good lender will have some kind of information about themselves readily available online, such as a robust business website, authentic customer reviews and a social media presence. If you can’t find anything to suggest the company has legitimate, current customers, it might be best to reconsider that lender, Stunzi advised. He also noted that a “squeeze page” – a contact form that asks for personal details to access information about the company or its loans – is a warning sign of a potential scam.
Typically, having access to more money than you need is a good thing. However, when you’re borrowing, it’s important not to bite off more than you can chew. Salters cautioned against signing with a lender that wants you to agree to a larger loan amount than necessary for your business.
“If a lender or broker is pressuring you to take more money than you need, that is a clear sign to end the transaction,” Salters said. “Larger deals mean larger commissions, while you can end up upside down [on your loan].”
Taking out a loan, big or small, is a serious financial commitment. Before you agree to anything, you should be able to ask the lender as many questions as you need to feel comfortable with the loan’s contract terms and payment schedule.
Stunzi warns that you should walk away if a lending representative tries to rush you into signing paperwork before allowing you to review everything. This is especially true if there are multiple loan options available. A good lender will act as an advisor and walk you through the pros and cons of each before you make a final decision, Salters explained.
“People jump the gun and sign the papers without understanding what they’re getting into,” Niefeld added. “Really understand the loan and your responsibility as the borrower [before you sign]. Be a part of the plan. Don’t be ‘sold’ anything.”
If you find a lender that passes the red-flag tests, alternative funding sources can provide your business with significant benefits.
If you’re in the market for vetted alternative lenders, check out our picks for the best business loans. We spotlight alternative lenders worth considering that you can research further:
Alternative lending is very different from conventional financing. While it offers a unique set of benefits for businesses that use it correctly, it can also be fraught with potential problems. When seeking funding for your small business, note any red flags and always be sure to use a reputable provider.
Dock Treece contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.