A recent article in Bloomberg entitled Wall Street Finds New Subprime With 125% Business Loans talks about the recent phenomenon of extraordinarily high interest rate business loans. The article goes on to detail the exploits of a company called World Business Lenders and how a loan they offered carried a 110% interest rate.
Bloomberg's reporter got the math wrong. The loan they describe is actually a 170% interest rate.
Why Can't Bloomberg Calculate the Interest Rate on a Small Business Loan?
It's hard to find too much fault with the reporter. People that have never seen a Bloomberg machine can't even fathom the immense amount of information coming through those terminals - I don't know which experience was more transformational between seeing my first dirty magazine as a kid or seeing my first Bloomberg as an adult.
The reporter tells a story of the Kasems, who take out a $12,500 business loan with payback terms of $18,236 over six months via payments every business day of $144.73. Since $18,236 plus $1,000 in fees is almost 55% higher than $12,500, the reporter just doubled the six months to convert that to a 110% interest rate.
The only problem - That's not how to calculate an interest rate.
How to Calculate Interest Rates for a Small Business Loan With Daily Payments
So, it's not totally fair to call a big giant "fail" on Bloomberg, because technically, if they were calculating simple interest, they'd be right. The problem is, the vast majority of people assume when they read an article like this that they're being described an interest rate like the bank does it, called an APR.
It's hard to explain the difference between the two without someone looking at me like I'm trying to tell them a trigonometry question in Chinese, but I'm going to give you the easiest explanation I can:
When you get your mortgage statement, you'll see part your payment goes towards interest and some goes towards principal. In the case of a mortgage, you pay once a month and the amount you pay over and above the interest rate pays down your principal, so the next months payment is calculated based on the new principal amount. Bankers have a fancy word for it called "amortizing."
Now on a loan like this, payments aren't monthly, they're made every business day, which makes the calculation tricky, but the rate when calculated without that $1,000 mentioned fee comes out to about 170%. If you're a fellow finance geek you can check my math here .
How Can World Business Lenders Get Away With Charging Rates this High on a Business Loan?
We talk a lot, both on our website and to our clients, about how rates don't always matter that much, but there's a limit to what's fair and reasonable and what's just trying to screw over Main Street America. The government doesn't get involved in regulating small business lending, and this is a good thing because they'd really screw things up, but for those of us in the business of helping small businesses access capital, the responsibility lies with us to present our fellow business owners loans in a transparent, fair and ethical manner.
I can't speak to the business practices of World Business Lenders, as I spoke with them once, and upon seeing their rate sheet, refused to do business with them. There's no such thing as a bad loan, only bad fits, but the problem with a lot of these lenders that charge crazy interest rates is they aren't hiring salespeople with the skills to distinguish between a good fit and a bad fit, they hire a shop full of used car salespeople who are interested in their own best interest and not that of their borrowers. Note that you can sometimes get out of bad business loans too.
How Can You Avoid Getting Ripped Off By a Small Business Lender?
First and foremost, if you need a loan and you can't qualify at the bank or the SBA, you should work with someone who has access to numerous funding sources, so that they may place you with the option most appropriate to your situation. Secondly, you may test the person you're talking to by asking what the interest rate is. If they mumble at you that there isn't an interest rate, which is what makes the loan so great, you've got a shark on the line and it's time to cut bait.
If the person on the other end of the phone is transparent with you about what the rates are, and has a number of different options to talk about with you, you've probably found yourself a winner.
If you're in the market for a small business loan, we can help you find the option most appropriate for you. Simply contact us or give us a call at (800) 786-5696.