If a traditional small business bank loan isn’t what you’re looking for — or if your credit won’t qualify you for one — you may have looked into alternative lenders as a different source of funding.
And there are some reasons why alternative loans appeal to people: you can get them much faster than traditional loans (usually same-day) and your credit history doesn’t keep you from getting access to money.
But buyer beware: there are plenty of reasons to hesitate before going down this path. Alternative lenders aren’t there to graciously lend you money; they’re there to make money for themselves.
A few years ago, an alternative lender was your only option of financing if traditional loans weren’t an option, but now you’ve got more options, which we’ll cover in a bit. First, it’s important that you understand how dangerous alternative loans can be for your finances.
1. They have an exorbitant APR
An alternative loan will almost always have a shockingly-high annual percentage rate, sometimes exceeding 100 percent. Because these are short-term loans that are paid back quickly, the daily percentage rate isn’t that huge a cost if you’re planning on paying it back in just a few weeks, but in the event that you can’t pay back it right away and the weeks drag by, an alternative loan can end up costing you far more than you initially budgeted.
Before you take out an alternative loan, look at the payback period and calculate how much you would pay in interest before applying for it.
2. They require an aggressive payback
Because these aren’t loans that you pay back over months or years, you may be spending more than you can afford on loan payments in the short term. Some merchant cash advances will front you money and then take out a chunk of every debit or credit card payment you get from customers, plus fees. Depending on the rate you pay for this privilege, paying the advance back could seriously jeopardize your cash flow, putting you more in the hole than you were before you sought financing.
Find out how much of a given card transaction you will have to give up in order to pay back the advance. Determine if it will leave you enough cash to pay your other expenses. If you’ll have a cash crunch, look for better financing options.
3. They don’t help your credit
Because alternative lenders aren’t regulated in the finance industry, taking out an alternative loan and paying it back quickly won’t put a green plus mark on your credit score the way a traditional loan would. Because these forms of financing aren’t considered loans (they’re technically “cash advances”) they aren’t required to report financing for their customers.
If you’re funding your company, ideally you’d get some “credit” for paying the loan back quickly. Building up your business credit report can help you qualify for lower-interest-rate loans down the road, as well as make you more appealing to investors. Getting an alternative loan won’t help you on this path, unfortunately.
Beyond needing a cash infusion right now, ask yourself what else you need to get from borrowing money. If improving your credit score is on the list, alternative loans aren’t the best path.
Alternative to alternative lending
These days, there are better ways to quickly get funds for your business. Not every business qualifies for an SBA loan, but merchant cash advance can be a viable option for small businesses.
While a business loan provides you with a set amount of money that you pay back little by little, a cash advance is paid back daily with a portion of your credit/debit card sales. The downside of merchant cash advances is the amount of interest you need to pay on the amount advanced to your business. For instance, if you receive $75,000, you may have to pay back $97,000 or more, which is 30 percent-plus interest on top of what you received.
There are plenty of other alternatives that you can look into. Financing of any type is something you need to consider carefully before jumping into. Alternative lenders make it far too easy to get capital, but before you apply, make sure it’s really essential for your business. No matter what path you choose, you’ll pay fees to get access to money, and you need to be sure that your business can afford to pay for the privilege.
Article and image provided by: Sacramento Business Journal