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In today’s rapidly evolving financial landscape, businesses are constantly seeking sources of capital to fund their operations, growth, and strategic initiatives. While traditional banks and financial institutions have long been the primary source of business financing, a growing number of entrepreneurs and companies are turning to non-traditional lenders to secure the funding they need.
Is your email inbox full of offers for “24-hour funding”, “quick closings”, and “unsecured loan offers”?
Non-traditional lenders, such as online lenders, peer-to-peer lending platforms, and fintech companies,
offer an alternative to the conventional banking system. However, this shift towards non-traditional
lending options is not without its risks.
Businesses borrowing from fintechs can face several challenges. According to a study by Marco DiMaggio and colleagues, businesses turning to fintech lenders are more likely to spend beyond their means, sink further into debt, and ultimately default more often than people with similar credit profiles borrowing from traditional banks.
The study also found that fintech borrowers only partially consolidate their debts, and then a few months down the line, they know that they have these credit cards that are empty, and they start using them again. This leads to leverage ramping up again, but now they have to repay both the credit card debt and the unsecured loan, which causes their defaults to skyrocket.
Businesses borrowing from online lenders face several potential risks. One of the most significant risks is the high interest rates charged by online lenders, which can be much higher than those charged by traditional banks. This can lead to a cycle of borrowing, where businesses are unable to pay off their loans and end up taking out additional loans to cover their existing debts.
Understandably, there are many times fast funding is necessary to take advantage of an unexpected opportunity, but there has to be a return in that opportunity that allows the business to pay the debt back rapidly without penalty. Small businesses should seek the advice of a trusted advisor before entering a loan agreement that may turn out to be nothing more than a boat anchor cleverly disguised as a good deal.
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