Che Al-Barri remembers feeling like he was drowning in debt last year. He had taken out a $70,000 loan for his small cleaning company, but was struggling to repay it.
The lender, a financial technology -- or fintech -- company, automatically collected $331 from his bank account daily, Monday through Friday. The frequent hits depleted his income and took a toll on his business, he said.
"If you get hit every single day you have no time to breathe," said Al-Barri, 45, who grew up in Richmond. "It put me up against the wall. There was many times I pulled the covers over my head and just laid there like, 'Oh my gosh, what am I going to do?'"
Al-Barri's predicament points to an intensifying debate about the booming online lending industry.
Many observers see glittering potential for fintech companies to solve an age-old problem: connecting entrepreneurs -- especially in minority and low-income communities struggling to get financing from banks -- with capital to grow their businesses. Critics counter the fast-changing sector is operating in a regulatory void and that some online lenders are sinking vulnerable business owners with exorbitant costs and grueling repayment terms.
For Al-Barri, taking a big loan seemed like a great opportunity at first. Large clients were taking months to pay him, he said, and he wanted to buy equipment and hire employees to expand. But he underestimated how much he would earn, making it very difficult to repay the loan plus the $30,000 in interest he owed.
“I was trying to get out of a bad situation and jumped into a worse one," said Al-Barri, who declined to name the online lender. His company, J.C. Professional Services, cleans high-rise windows, solar panels and office buildings throughout the Bay Area.
Fintech companies use electronic data and computer algorithms to screen borrowers quickly, in a matter of hours or days, usually through online applications. Applicants typically apply for loans under $250,000, the amount most small business owners in the U.S. are looking for, researchers say. The cash for the loans comes from banks, hedge funds and other investors.
A Rapidly Expanding Industry
During the Great Recession, as big banks cut down on their small business lending, fintech stepped in to fill the unmet demand for credit. The industry has boomed, putting it on track to lend as much as $90 billion a year by 2020. That's according to analysts cited in a report by the U.S. Treasury Department.
Fintech lenders are expanding access to capital while slashing the time and cost of underwriting small-dollar loans. That's a game changer for entrepreneurs trying to grow and create jobs, said Karen Mills, a senior fellow at Harvard Business School.
"I think this is a really positive thing for the small business owner," said Mills, who headed the U.S. Small Business Administration from 2009 to 2013.
The innovations in financial technology, Mills added, could particularly help women- and minority-owned businesses, as well as other markets underserved by traditional financial institutions.
But as more small business owners have run into trouble after taking expensive online loans, there's been a growing call for greater oversight, said Mills.
"If fintech is going to be a solution for small-dollar loans, it is extremely important that we make it transparent and make sure the bad actors don't take advantage of some of these small business owners," said Mills, who is working with federal regulators on the issue.
Online Loans Are Fast and Easy To Use, Say Borrowers
Convenience was a major reason Tina Paclebar and Jane Nacelli, the owners of a Hayward delivery company, began using online loans from a San Francisco-based fintech company called Fundbox.
When they applied over a year ago, Fundbox connected to their accounting software. Fundbox's algorithms then crunched through their income, expenses and how much they were owed by clients, to calculate whether to give them a revolving line of credit.
Now, with the click of a button, Nacelli and Paclebar can borrow up to $22,500, and the money will be deposited in their bank account within two days, they said.
"It's convenient and integrated and it gives you that peace of mind that you have a backup plan when you need plan B," said 46-year-old Paclebar. The couple has used those loans to buy vehicles to expand their business and cover drivers' salaries when clients take longer than expected to pay.
Paclebar and Nacelli had applied to their longtime bank, Citibank, for a $75,000 loan to upgrade their vehicle fleet this year. But after turning in their paperwork, going through interviews and waiting for weeks, the bank rejected them, the women said.
"Big banks have not worked for us," said Nacelli, 41, adding that the bank cited minor past late credit card payments for declining the loan. Citibank declined to comment on their application, citing customer privacy.
In contrast, Fundbox doesn't consider personal credit scores when deciding whether to approve a loan. That opens the online lender to work with entrepreneurs who may have lower personal credit scores but growing businesses, said Greg Powell, who directs marketing at Fundbox.
"That's why what we're doing is, I think, so important. We are really looking at the health of the business and not the individual," Powell said.
Still, the quick access to cash comes at a cost. Fundbox’s clients face an average annual interest rate between 40 and 50 percent, something savvy customers like Paclebar and Nacelli are keenly aware of.
"You do look at the fees and you are like, 'Wow, that’s a lot,'" said Nacelli, pointing to the fees of up to $1,000 for a $6,500 loan. "But if you take only what you need and you pay it back early, it's a great tool."
Fundbox and other online lenders allow borrowers to save on weekly or monthly fees if they pay back a loan's original amount early, a key feature that Nacelli uses to reduce the expense of their online financing.
Powell argues that using annual interest rates to measure his company's fees inflates the cost of its loans, because their clients have a shorter repayment term, just 3 or 6 months. In addition, his company discloses the dollar amount of their fees up front, he said.
"No one is ever surprised with the amount that they need to repay," said Powell. "We are able to serve small business with the number one thing they need, access to capital, in a fair, transparent and user-friendly way."
'Nothing Short of Online Payday Lending'
While some online lenders are working responsibly, others are less transparent about their costs and underwriting, said Eric Weaver, CEO and founder of Opportunity Fund, a nonprofit lender that has helped dozens of small business owners refinance expensive online loans. In other cases, Opportunity Fund has been unable to help business owners too deep in debt, said Weaver.
"Some of these lenders are just lending people way more money than they could afford and they're not disclosing the terms transparently. They never quote an APR," or annual percentage rate, said Weaver.
A state survey of more than a dozen fintech companies operating in California found the median APR for small business loans ranged from 15 to 51 percent. But some online lenders reported loans with APRs of more than 100 percent.
Those high costs can force mom and pop shop owners to close, said Jose Corona, director of equity for Oakland’s mayor's office.
"When you peel down the layers and see the products they are offering, it’s nothing short of online payday lending," said Corona, adding that surveys by the city have revealed that many fintech borrowers are Latino, African-American or Asian residents.
"They'll go to the minority business to say, ‘Look we have a solution for you.’ But their terms are so predatory that it can actually put people out of business," said Corona, who for years directed a local organization that trains and invests in small businesses.
Online Lenders Say They Offer Opportunity
As in other lending industries, riskier customers pay higher costs because they are less likely to repay a loan, said Kathryn Petralia, president and co-founder at Kabbage, one of the largest fintech business lenders in the U.S.
"Those risky businesses do pay more, but they need a chance," said Petralia, whose company offers short-term loans with APRs from 18 to 99 percent.
"They have an opportunity to do something they really wanted to do with resources that were previously unavailable to them because nobody thought they were worth it," she said.
While it's true that some customers facing the highest interest rates default on their loans, said Petralia, others are able to use that money to turn profits and become more stable borrowers over time.
The company benefits from clients fully understanding the total cost of their loan so that they are able to calculate if that financing will work for their business, said Petralia.
That's one reason Kabbage, On Deck and other fintech business lenders created an easy-to-read price tag last year -- they call it a Smart Box -- that shows the annual interest rate, fees and total cost of a loan before customers click yes on it.
This effort by online lenders to increase their transparency is a sign that the industry is maturing, said Harvard's Karen Mills.
"Phase one was the Wild West. Phase two is partnerships with more banks," said Mills, referring to deals such as JPMorgan Chase turning to online lender On Deck to make more small business loans to the bank's customers.
Regulators Try to Catch Up
Currently, fintech companies deal with a mix of regulators that oversee different aspects of their business at the state and federal levels. That's why representatives at Fundbox and Kabbage said they are interested in a new proposal by the federal agency that regulates large national banks.
The U.S. Treasury's Office of the Comptroller of the Currency is considering a license that would allow online to operate as "special purpose" banks nationwide. The companies that apply for such a license would not take deposits from customers.
"We all need the federal banking system to be more inclusive, to accommodate new banks, and to adapt to the changing needs of the marketplace, customers and communities," said Keith Noreika, acting comptroller of the currency, in a July speech.
California regulators are against such a federal license because it would result in losing authority to protect consumers, said Jan Lynn Owen, the commissioner of the state's Department of Business Oversight.
"We are on the ground, we see issues faster," said Owen. "We also believe that the state laws do a much better job of addressing anti-discrimination and fair lending."
New York State and the Conference of State Bank Supervisors sued to stop creation of a national fintech license, arguing that federal authorities are overstepping their authority. Owen agrees with that assessment. California has historically overseen alternative lenders that do not take deposits and she said most online lenders fit that bill.
Her agency is gathering data from fintech lenders and looking into requiring companies operating in California to be licensed with the state even if these online lenders are working with out-of-state banks to originate loans, she said.
"The laws that we currently have on the books aren't always in the 21st century," said Owen, who has been meeting with heads of fintech companies to better understand their business. "We look to these companies to help us change the laws."
Che Al-Barri, the cleaning company owner, is wary of too much regulation. He said it could put financing out of reach for people like him.
"If everything gets so regulated that it’s just like banks again, I would have never gotten in a position where I would have gotten any kind of funding," said Al-Barri. He added that before he opted for his online loan, he was rejected by several banks.
Al-Barri's online loan documents did not disclose an annual interest rate, but what really hurt him, he said, was believing the loan would be a good bet for his business.
"You know how they say ignorance is bliss? Ignorance is deadly. It can kill you financially," said Al-Barri.
Since struggling with his loan, he decided to educate himself on how the financial system works and how to use it to his advantage.
He has read his copy of "Personal Finance for Dummies" several times, and during his long drives across the Bay Area for work, he listens to audio books on finance.
"Financial literacy is the key," said Al-Barri. "If you don't know how to manage your finances and business, you're going to lose it."
Al-Barri was able keep his business. He used his income and borrowed from close friends and family to repay most of his loan. He was then able to refinance the remainder of his debt through Opportunity Fund, the nonprofit lender, at a lower interest rate.
Now, he gets offers for more financing "all the time," he said. But he ignores them.