The competition continues to intensify between Canadian bank and non-bank lenders to carve out their share of the $18.4-billion market for small-business loans of up to $250,000.
But as entrepreneurs assess their options, here are 10 points to consider that, in addition to the headline interest rate, impact the total cost of borrowing.
1. Due Diligence Cost
No matter what type of loan you are seeking, every lender will do their homework on you. Their diligence can be as simple as pulling a credit report or as in depth as conducting an appraisal of your assets or an audit of your financials. There are generally two types of costs associated with due diligence - time and disbursements. Before agreeing to a lender conducting due diligence, ask who is responsible for covering each of these costs and understand the magnitude of what these costs can be. Don't give the lender free reign to spend as much as they want without implementing a cap.
2. Legal Costs
In order to secure a loan from a reputable lender you will be required to sign a loan agreement. Depending on the complexity of the loan (and whether there is real property involved), the agreement may be as simple as a standard boiler plate loan document that doesn't require involving lawyers or as complicated as a multiple document package that a lawyer has to draft and customize to the specific transaction. Understand the scope of the transaction before you consent to the lender engaging legal counsel and make sure the lender lays out all the legal costs (including disbursements and taxes) ahead of time. If you are entering into a longer term relationship with a lender, they may be inclined to absorb much of the cost in order to maintain the relationship.
3. Administrative Fees
Often lenders will charge a monthly fee to cover the costs of administering and monitoring the loan. This fee is charged regardless of whether you have a loan amount outstanding that month and can range from a few dollars to thousands but typically it is between $50 to $100 per month. Some lenders will also charge an annual review or renewal fee. This should be identified up front so that there are no surprises. If it is not, make sure to ask the lender for any future potential fees and to have them confirm in writing that the only possible costs are those laid out in the loan agreement.
Try to match the length of the loan with the amount of time the cash is required. You may pay a lower headline interest rate on a longer term loan but, if you are forced to keep the loan outstanding for longer than you need it, it may end up costing more overall. A $10,000 loan at an annual interest rate of 12% (1%/month) with a one year commitment will cost $1,200 in interest. However, if you only needed the loan for three months, you could have taken a higher interest loan (some personal asset lenders charge 2.9%/month) and actually saved money by only paying $870 in interest, a savings of $330 or 28%.
5. Minimum Increments
Many lenders, especially banks, round up the loan amount to a set increment, usually $5,000. This means that if you need to borrow $5,500, you will actually be charged interest on $10,000. If a lender insists on including minimum borrowing increments into their loan agreement, try to negotiate as low an increment as possible. In this example, had the increment been $500, there would be no additional rounding and had the increment been $1,000, you will only be charged interest on $6,000.
6. Monthly (or Annual) Minimums
Before approaching lenders, prepare a detailed monthly cash flow statement to understand exactly how much to borrow on a monthly basis. Often lenders will require clients to have at least a pre-determined dollar amount outstanding on a monthly basis in order to get the advertised interest rate and may charge a penalty if you drop below this amount throughout the month. You can usually negotiate this amount upfront and having a detailed cash flow analysis to show the lender will enhance your position.
Instead of a monthly minimum, some lenders may phrase this as an annual "true-up" where they calculate what the annual interest earned should have been and then require the borrower to top it up if the actual amount earned by the end of the year was lower than the expected amount.
7. Termination Fee
Loan agreements are typically set for specific lengths of time. If the borrower wants to end the relationship early, a lender may charge an early termination fee. The fee can be phrased in many different ways. It may be tied to a minimum annual dollar interest amount or, it may be called a "security discharge fee" where the lender charges you when they discharge their security (which needs to be done in order for any new lender to get involved). Another way that lenders can lock you in for a period is to write into the loan agreement that they require 60 or 90 day notice prior to terminating the agreement, which in itself can act as a termination fee if you have to continue paying interest for a period in which you do not need the loan.
8. Transaction Fees
How does the lender advance you the funds every time you need to borrow from them? Do they wire you the money, deposit the cash directly into your bank account, send you a cheque or load a pre-paid credit card? These logistical questions can have a big impact on the cost of borrowing - especially if you are borrowing often. Lenders can charge a transaction fee each time they advance the money, and there are different costs associated with different ways of transferring money. Wiring funds can cost a lender between $25 to $40 for the outbound wire (which gets passed on to the borrower) and a borrower $10 for the inbound wire, regardless of the amount wired. Understand what the costs are prior to agreeing on a method of loan advance and determine if the lender will cover those costs.
9. Insurance Costs
There is insurance for practically anything today. Different types of lenders will require different types of insurance and often the borrower bears the cost of that insurance. For example, personal asset lenders that hold an asset as collateral will need to ensure that the asset is insured while in their possession. Some lenders may require you to have general business liability insurance, key man insurance or accounts receivable credit insurance. They may even require you to pay to insure the loan in the event you are unable to repay.
10. Intangible Costs
In addition to the actual dollar costs of a loan today, choosing the wrong lender can have long term cost implications well into the future. There are some lenders that can actually increase your borrowing costs in the future just by showing up in your credit report during the due diligence process. Payday lenders are the classic example that, if shown on your credit report in the future, will lead to a higher cost of borrowing. Loans that do not have an impact on credit score, even if they have a higher cost today, could actually save you money down the line by avoiding blemishes on your credit record.
There is also the opportunity cost to consider. Even if a loan carries higher costs, the immediate accessibility of the cash may still make it a good deal if you have an immediate profitable use for that cash. Some lenders are able to fund within 24-hours, whereas banks and other traditional lenders may take weeks or months to approve a loan.
Steven Uster is the Founder of Zillidy, a Canadian private alternative lender that provides personal asset loans secured using jewelry, luxury watches, gold, diamonds and precious metals as collateral. Zillidy's loans provide a line of credit without impacting credit scores or requiring the sale of valuable or sentimental assets. Steven is also the Founder of Eldridge Capital, which provides accounts receivable factoring for Canadian companies.