Payday lenders have faced intense scrutiny over
the last decade for their predatory and aggressive lending practices. Payday lenders, such as Kwik Kash, Money
Mutual, and Speedy Cash, provide loans to vulnerable consumers facing financial
hardship. While these loans may provide
the short-term relief sought after, quickly these loans trap many of these
consumers in a cycle of debt.[1] Payday lenders typically charge 400% APR or
more on their loans, so consumers often end up paying hundreds in interest on
fairly small loans.[2] Thus, what once looked like a lifesaver to
many of these consumers becomes a very large financial burden in itself. Because payday lenders are so common and
popular for consumers facing financial emergencies, the effects of their
exploitative business strategies are far reaching.
While a majority of the recent outrage over fast
cash loans has focused on the payday loan industry’s harm to individual
consumers, the merchant cash advance (MCA) industry’s deleterious effects on
small businesses should not be underestimated or overlooked. MCAs can be applied for online, don’t have
stringent credit requirements, and can often be received the same day. All of these factors make them a very popular
financing option for small businesses in search of capital. These loans work in much the same way that
payday loans do; they too carry exorbitantly high interest rates and contain
many hidden fees. These terms make it
nearly impossible for these already cash-strapped businesses to pay back their
loans on time. Thus, many of these
businesses seek out additional loans to pay off their existing debts and get
trapped in the same cycle of debt that payday loan consumers find themselves
in. MCA lenders also often require their
customers to sign Confessions of Judgments, which leave their customers without
legal recourse when they want to dispute a claim.[3]
The problems created by this industry will
become particularly acute as more small business owners face financial distress
as a result of the COVID pandemic. Small
businesses often lack the capital necessary to handle long-term unexpected
slowdowns or shutdowns of their operations.
As a result of COVID shutdowns, many small businesses have had to figure
out ways to cover their normal overheads with severely reduced income streams. Because it often takes weeks to be approved
for traditional bank loans and other sources of funding, like grants, are
especially competitive right now, many small businesses are turning to quickly
obtainable and easily accessible MCAs.
The effects of the pandemic on these small businesses will extend far
beyond the COVID shutdowns as they struggle to get out of the quick cash cycle
of debt and pay the large interest payments on these loans.
Unfortunately, there isn’t much oversight of
this industry. MCAs work differently
than other loans, allowing MCA lenders to evade regulations that would
otherwise protect their customers. MCA
lenders provide cash to their customers in exchange for a cut of their
customers’ future credit card sales. As
such, unlike traditional lenders, they aren’t providing cash in exchange for a
promise to be paid back. Because of
this, MCA lenders aren’t subject to usury laws or the Truth in Lending Act and
can get away with charging high rates and fees on their loans.[5] While the Federal Trade Commission (FTC) has
recently sued several MCA providers for making misleading statements about the
terms of their MCAs to customers, there is still very little protection for
small businesses in this industry.[6]
Seeing as regulations aren’t in place to
protect small business owners from these predatory lending practices, small business
owners must educate themselves about these loans and seek alternative funding
solutions. These loans are notoriously
difficult to understand, as interest rates aren’t annualized, timelines are
muddled, and many terms are hidden in the fine print. Thus, businesses that are considering MCAs
should carefully consider what the short-term relief of an MCA will cost them
in the long-run. Luckily, there are
several alternatives for small businesses seeking capital. Businesses considering MCAs should instead
consider short- or long-term bank loans or lines of credit, SBA loans, and
asset backed loans. These other options,
while harder to obtain, will provide necessary financial relief without
sacrificing the business’s long-term prospects and financial health.
By Gabriela Hindera
[1] How Payday Loans Work, In Charge Debt Solutions, https://www.incharge.org/debt-relief/how-payday-loans-work
(last visited March 1, 2021).
[2] How Payday Loans Work, Payday Loan Consumer Information, https://paydayloaninfo.org/facts (last visited
March 1, 2021).
[3] The Ugly Truth About Merchant Cash Advances,
Opportunity Fund,
https://www.opportunityfund.org/the-ugly-truth-about-merchant-cash-advances
(last visited March 1, 2021).
[4]
https://www.austinmonitor.com/stories/2017/05/judge-rejects-citys-payday-lender-rules/
[5] Merchant Cash Advance Regulation: Does It
Exist? What You Need to Know, Fundera,
https://www.fundera.com/business-loans/guides/merchant-cash-advance-regulation
(last visited March 1, 2021).
[6] Protecting Small Businesses Seeking
Financing During the Pandemic, Federal
Trade Commission, https://www.ftc.gov/news-events/blogs/business-blog/2020/08/protecting-small-businesses-seeking-financing-during
(last visited March 1, 2021).