Dealing with Loan Brokers Can Be a Slippery Slope

May 21, 2014
pic-money-hands*This article was contributed by Jason Fleming, Dealstruck Inc., a corporate partner of NSBA.

As a lender in the small-business community, working with loan brokers is just another part of our business, unfortunately there can be downsides to working with a loan broker. After introducing us to a borrower that we ultimately were able to fund, a particular broker recently asked us to collect his additional fees for him because the borrower was not willing to pay.

The borrower later explained to us that he was extremely unhappy with this broker because the broker shopped his application out to a handful of merchant cash advance providers, each of which pulled his credit (and harmed his credit score), only to offer him costly products that he had no interest in accepting.  He received a handful of offers with rates exceeding 70 percent APR and short-terms of six to nine months that would have strained his cash flow. Dealstruck’s offer ended up being over 80 percent less expensive and with far more manageable payments.

While this borrower was happy with the product and service he received from Dealstruck, that broker experience caused some heartburn among our team.

A LOOK BEHIND THE CURTAIN – THE BROKER’S MOTIVATION

If the broker had taken the time to listen to the borrower, he would have learned that the borrower had strong credit and was eligible for financing at competitive rates.

If the borrower could get a competitive product, why was he being pitched loans with sky high rates?

The answer is simple.

High cost financing providers are willing to pay hefty fees to brokers because they know that their products are difficult to sell.  And the brokers that typically work with these high cost providers are more motivated to line their pockets than to serve the borrower with the healthiest possible product.

In fact, Businessweek just featured an article on this very issue last week, entitled “Brokers Get Big Commissions for Selling Entrepreneurs Costly Loans”

In his article, Patrick Clark mentions,

“…[B]ehind the high-tech gloss, alternative lenders rely on an old-fashioned method to find borrowers: loan brokers. These independent agents funnel cash-strapped business owners to dozens of companies that fund merchant cash advances and other high-cost loans. And their sky-high commissions, usually hidden from merchants, can double the cost of already expensive loans, according to industry insiders and documents describing commission structures obtained by Bloomberg Businessweek.

“In one example, a business borrowing $50,000 over six months could repay $65,500, with more than half the effective interest going to the broker. The [broker] commission of 17 percent far outstrips the one or two percent brokers earn on loans backed by the Small Business Administration.”

To be sure, many loan brokers do invaluable work steering clients to the right lender—particularly when they know the lender has a specific focus on an industry or style of transaction. This not only leads to more affordable financing but a structure that serves the borrower’s goals most effectively.

At Dealstruck, it is extremely important to our mission and team that we do not allow high-priced brokers to take advantage of our borrowers.  For that reason, we have a policy that we will only pay a broker  one percent on each loan that they facilitate, pushing the benefit of the loan back to the small business.

Key Takeaway:  When you are seeking financing, first be sure you are going direct to the lender whenever possible, to cut your ultimate cost.  And if you do decide to work with a loan broker, be sure you know what their fee structure is upfront.  The higher the broker fee, the more likely you will be pushed to the highest cost option in the market.