Real Cost of Merchant Cash Advances & Online Loans
Steve Capper–Principal/CEO - June 6, 2016
You have probably seen the ads. There is a huge new world of ‘Online’ lending now available, and the number of web companies offering Internet loans are growing exponentially. Their websites, web portals, and interfaces are designed, touted, and advertised as a way to get money easier, faster, and with less friction. Deceptively, many of them are some of the highest rate loans offered anywhere. And millions of people are falling for it.
Here we will show you how to determine the true rate and how these online loans are portrayed as being less expensive than they really are. It is not uncommon for an online loan that is purported or believed to be at a 10% rate to actually be at a 70% annual interest rate. Some of them are even above 80% interest rate annually. There are many variations of these loans, but common warning signs that allow lenders to get astronomical high rates include:
Shorter loans. Three month or six-month loans are better opportunities to disguise the annual rate or true cost.
- The costs are stated as ‘fees’ rather than rate, interest, or interest rate. They might express the cost as a ‘rate’ but in such cases they usually won’t tell you an exact cost but rather imply a range of cost, for example 10% to 30%. Even then, the true cost may be more than triple that range.
- The lender has access to your bank account, which you pre-authorize. And through your bank account there is DAILY payback of the loan.
- The online lender will show you great, up-to-the minute detail of the total dollar amount of the loan and the total dollar amount paid back. You must fend for yourself to figure out the actual rate, if you can. Most people cannot.
Here is how many easy online lenders get themselves 40% upwards to 100% annual interest rate on their loans–
If you took out an online loan of $10,000 (ten thousand dollars) for three months, and by the end of the three-month period you paid back a total of $11,000 you might believe that your rate for the loan was only 10%. You paid $1,000 for the use of $10,000.
($1,000 divided by $10,000 = 10%.) That is what the easy online lender wants you to believe on your own, and their website may even imply or state as the cost.
You must not forget that this above example is a three-month loan which is fully paid back in three months. If you took out a series of these $10,000 loans under the same terms (three months with full payback within three months) with this easy online lender for an entire year, you would pay 10% for each three month period. That would be a total of 40% annual interest rate…10% for the first 3-month period, 10% for the second 3-month period, 10% for the third 3-month period, and 10% for the fourth 3-month period.
Although you may want to believe that your loan is at 10%, and your easy online lender also wants you to believe so, your effective annual rate for the 3-month loan is a MINIMUM of 40%. IT IS ACTUALLY MUCH HIGHER THAN THAT! There is a second part to the actual true effective rate embedded in the element of ‘daily’ payback of the loan.
Again, your online lender would love to tell you or imply that you paid 10% rate for a three month period. That may seem true but only if the ENTIRE loan was paid back at the very END of the three months. You must remember that the online lender is pulling money out of your bank account and getting a portion of their loan paid back every day. If the loan is a 90-day three month loan, on average they have themselves half paid back in half the time of 45 days. So on average they are getting the 10% for ’45’ days (on half the loan), not for 90 days.
There are 8.11 forty-five day periods in an entire year. (365 days divided by 45 days.)
If an online loan company got 10% for each of these periods they would be getting 81% annual rate (10% x 8.11). In this case they are getting half or 50% of their loan paid back by 45 days, at 81%. 50% x 81%= 40.5% is what they are making on half the loan.
The other half (50%) of their loan is completely paid back by the end of 90 days/three months. As we know from our earlier calculations, they get 40% annually on that portion (which is paid back in the second half of the three month window.) 50% x 40% = 20% is what they are making on the other half of the loan.
Now lets add it all up.
50% of the loan x 81% = 40.5%
50% of the loan x 40% = 20%
60.5% annual interest rate cost of the easy quick online loan
This calculation is a rough estimate. If you were to enter the numbers from this example into an online amortization calculator (such as https://financial-calculators.com/amortization-schedule), you’d discover that the true APR of a $10,000 3-month loan with a $1,000 “fee” is actually 76.95%!
To add insult to an injury, many of these lenders also get an additional origination fee from you when you sign up for the loan.
The rate can be higher than a rough estimate considering accelerated rates of loan payback which might be
- The same dollar amount every day,
- A fixed, graduated, or varying percentage of the amount in your bank account each day.
The industry of easy online lending with quick loan approvals has many reasons for its recent large growth and with it comes new dangers. The industry is unregulated, and therefore ‘anything goes.’ With other loans such as credit card loans, bank loans, and auto loans, congressional bodies and legislatures have recognized the potential for rate abuse. Therefore, lawmakers established the gold standard of interest-rate comparison known as ‘APR’ or annual percentage rate to help one determine what the real interest rate is. For lenders subject to APR disclosure laws, stating the APR/ Annual Percentage Interest Rate quite visibly is mandatory. Quick Online lenders have not been required to comply with the disclosure laws even though the daily payback aspect of their loans boosts their annual rate to the point of breaking State usury laws.
Many already in the Online lending industry, and many soon to enter, are simply computer programmers aggregating data and creating algorithms for fast loan approval; they have no real experience in commercial lending. They are in the business to get loan origination fees and build excitement about their fast growing company (of loan originations). They are less concerned with loan payback. And they may only be in it so they can tout their growth to sell off their company at a big price…to somebody else with big pockets who also knows nothing about lending.
If the economy takes a downturn, it is believed among many lending experts that a lot of these Online lenders will implode…it could be the next mortgage crisis fostered by loans too fast and easy to people who should not have gotten them. Companies building loan-origination machines based on computer algorithms generally don’t have the organization and expertise to handle out-of-the box loan workouts. A loan ‘workout’ is a carefully-monitored temporary side deal to help get a troubled borrower through a crisis. Absent an experienced workout team and infrastructure, a customer is more likely to be thrown to the wolves/courts.
Online lending has many names including but not limited to ‘marketplace lending’, ‘Fintech lending’, ‘platform lending’, and ‘merchant cash advance’. There are online application blanks to fill in about yourself and your company before you are told much at all, along with soft language about how easy it is and lightening-quick approval. As with licensing softwares or computer programs, there will likely be an online contract that you will not take time to read and then quickly scroll down and click a box that says ‘I Agree.’ The ease of taking money is very mobile enabled for Millennials, who live through their cellphones, and may naively take money at rates they don’t understand. The Online lender will often not have been fully operating in lending for more than two years. And they will have massive advertising budgets for pop-up banners everywhere, including at partner sites such as Quickbooks. Major network television and radio spots are also part of the ad budgets.
Some of the earliest entrants in Online funding are based on the MCA model, also known as Merchant Cash Advance. Not necessarily for merchants, it is a type of lending focused heavily on the borrower’s historical cash flows as shown in their bank statements. One or two years of cash flows through your account are examined. You then authorize the lender to have access to your account, and they may also require access to all of your business data through your online Quickbooks accounting system.
These loans tend to be the very highest rate, and may or may not include some collateral, such as legal rights to your accounts receivable.
If you have credit worthy accounts receivables or invoices that can be used as loan collateral, it is better to not use a bank-statement qualification MCA lender. You are entitled to a much better rate elsewhere. If your accounts receivables are already pledged as collateral for a loan elsewhere, the receivables-secured lender may have contractual say-so as to whether you can pile on MCA loans on top of their receivables loan.
Many who have browsed or shopped Online lenders, report a common troubling aspect with some of them. Once you look at their site you may be an endless target of their unmerciful digital promotion and re-marketing…on steroids. Some are worse than others, but the level of daily emails from them can be frustrating and even harassing. Their business model is, after all, digital and data driven from sales to closing and beyond; sales ‘algorithms’ can be impersonal and are not always designed to hear your opinion that their product is not really for you.
Distinctions must be made though. Are you just looking at their site, or are you filling in easy and friendly blanks to see how much money you could get, or what the daily payment would be, or what the total amount paid back would be? When you fill in blanks to see possibilities or offerings, it may not be considered an ‘application’ but may nevertheless trap your data for email and re marketing purposes. The most annoying experiences initiate from sites that don’t represent a direct lender with it’s own funds. Instead it may be referral, broker, or marketplace site that will put it out for many associated lenders to compete for your business. In such cases there can be a deluge of endless emails coming to you. Here, you must also be aware of who may pull your credit report and when. One party we know browsed a competitive-marketplace Online lending site without reading carefully and the next thing they knew their credit report was pulled by eleven different lenders.
Flexible Funding’s payroll funding on invoices or utilization of accounts receivables as collateral for revolving lines of credit affords better rates and higher credit lines than impersonal online lending based on computer algorithms. And our payroll funding comes with a higher level of personal service and additional business support.