Online lenders vs traditional banks
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Small business loans have never been as varied as they are today. For business owners, this is a good thing. The explosive growth of the alternative lending industry has led to greater access to credit for small business owners that traditional banks have certainly hijacked. But it’s not at all.
Alternative loans have also changed the way those typical loan products we all know and love (or don’t) to work. For example, take your standard line of credit. Depending on whether you are considering a line of credit from a traditional bank or an alternative lender, you may be dealing with two quite distinct loans.
Refresher course: what is a line of credit?
Before discussing the main differences, let’s remember what a line of credit is.
Just to talk about the basics, a line of credit, or revolving credit, is an amount of capital that you can tap into when you need it or set aside when you don’t. If you take a certain amount to pay for inventory, equipment, payroll, or whatever else you need money for, then you’ll only have to pay interest on what you’ve used… And once you pay it back, those funds will go back into your credit limit. In many ways, they work the same way as a business credit card.
Although lines of credit can have their drawbacks, they are generally very flexible and useful financial cushions to deal with cash flow slowdowns or emergencies.
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Traditional banks vs alternative lenders
Now that we understand that, we can look at the main factors that set lines of credit apart from banks and alternative lenders.
In general, banks try to lend to more predictable small business owners. They take less risk and, following the 2008 financial crisis, banks tightened their restrictions even further by lending only to the most conservative investments. Although they have relaxed a bit in recent years, younger or smaller companies still struggle to enforce their strict standards.
Alternative lenders, on the other hand, actively reach out to underserved small business owners. While greenfield businesses, unprofitable businesses, or owners with difficult credit histories may still run into trouble, many other small business owners can find a loan to help their business grow. This isn’t specific to lines of credit, but it’s still an important difference to keep in mind.
The flip side is that alternative lenders charge more for borrowed money. Banks have the lowest interest rates, but alternative lenders have to compensate for their higher risk investments and flexibility, and that compensation comes in the form of more expensive cash.
A bank line of credit may have interest rates equal to or lower than your usual credit card, for example, while an alternative line of credit may vary between 7% and 25%, without including any fees. registration or withdrawal, or anything else. which could contribute to a higher APR.
As you might expect, banks usually grant lines of credit with higher credit limits. There’s a lot of overlap here — many alternative lines of credit break $1 million while many bank lines of credit go down to $10,000 — but, in general, banks give out bigger loans for less. They’re just much, much harder to qualify.
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Banks and alternative lenders offer unsecured and secured lines of credit. But let’s dive a bit into what exactly that means.
Unsecured simply means that a line of credit is not tied to any particular security. Unsecured bank lines of credit tend to be a bank’s smallest offering because, naturally, it’s the riskiest.
Banks also offer lines of credit secured by work materials and inventory, real estate, or even certificates of deposit, which are just money that you cannot withdraw and reinvest for a period of time. Some also issue general liens to secure their larger lines of credit. So in other words, if you want to take out a million dollar line of credit, you’re probably going to need seven-figure equipment, real estate, or other assets on which the bank can lean – and make a claim, in case you default.
Alternative lenders rely more on unsecured loans, but some lenders offer lines of credit secured by inventory, equipment, or even accounts receivable. Invoice lines of credit may seem a bit complicated, but they actually allow you to get paid immediately, even if your customers are late with their checkbooks. Overall, alternative lines of credit are a bit more original.
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Banks may be the biggest hitters, but alternative lenders are definitely winning at the racetracks. They’re faster, more efficient underwriters — as even JP Morgan realized when they partnered with OnDeck — and they’re much quicker to provide financing. Part of that comes with the territory of looser eligibility standards, but it’s mostly because alternative lenders are much more focused on superior algorithms and technology that allow them to automate more processes.
The line of credit is one of the most sought-after (if not the most) loan products available to business owners. If you’re going to an online lender looking for a line of credit similar to what you’d find at the bank, don’t be surprised if what’s on offer looks a little different. Either way, lines of credit are a great safety net for any small business and are a smart credit opportunity to seek out for most small business owners.