Why small businesses are turning to online lenders

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Small business owners are increasingly turning to online lenders to meet their credit needs. One in five small businesses looking for credit surveyed in 2013 applied to an online lender, a survey by the Federal Reserve Bank of New York reveals. And former Small Business Administration official Karen Mills (now a senior fellow at Harvard Business School) reports that online lending is the fastest growing segment of the small business lending market.


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The explosion of online small business lending has many financiers, regulators, experts and policy makers wondering: why are small business owners turning to this source of funding so much?

The answer is convenience.

Small business owners aren’t turning to online lenders to save money. Loans from internet credit sources are generally more expensive than credit from banks and other traditional lenders. It turns out that the cost of a typical online loan is closer to the cost of the median credit card loan than to the price of a typical term loan or line of credit from a bank. A study by economists from the Federal Reserve Board of Governors calculated that the average interest rate charged on an online loan is about double that of a traditional bank loan.

Those who run their own small business do not turn to online lenders because their chances of obtaining financing are better with them than with banks. While online lenders’ loan decision algorithms incorporate a wider range of information than most traditional small business lenders, allowing them to lend to borrowers with lower credit scores, internet lenders are in less likely than banks to approve loan applications submitted to them. . A 2014 survey of small business owners by the Federal Reserve Bank of New York found that online lenders had loan approval rates of 39%, compared to 59% for community banks and small regional banks. , and 45% for the large regional banks.

Related: How the decline of community banks is hurting small businesses

Small business owners are turning to online lenders because new creditors are offering loan products that better meet their financing needs. Many small business owners these days don’t need term loans to make large purchases, but rather need relatively small amounts of cash to handle short-term cash flow emergencies.

Online lenders are well placed to meet this demand. Their loans tend to be shorter in scope and duration than traditional bank loans, according to a report by consultancy Oliver Wyman and Company. Many online lenders also offer accounts receivable cash advances, a type of financing that’s especially useful for smoothing out lumpy cash flow.

Small business owners are also attracted to web-based lenders’ quick and easy application processes. In a survey of its customers, online lender OnDeck found that a significant number of its customers rejected the idea of ​​borrowing from traditional sources of credit because getting a loan from these lenders is “too much”. difficult” and “takes too long”.

Online lenders have accelerated and simplified the loan application, decision-making and fund disbursement processes. Estimates show that applications to these creditors take as little as 1/50th the processing time of those to traditional banks. Additionally, online lenders tend to accept or reject funding applications within hours, rather than the weeks it takes for banks.

Most small business owners believe that time, not money, is their most valuable resource. They prefer credit products that save them time, even if they cost more. Online loans are growing because many small business owners are willing to pay higher interest rates to quickly and painlessly obtain loans that precisely match their financing needs.

Related: Replacing the SBA’s Outdated 7(a) Loan Program

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