Pros and Cons of Alternative Business Lending

Qualifying for a small business loan can be challenging for borrowers with bad credit or low-revenue startups.  Alternative lenders can offer relaxed eligibility requirements and often streamlined application processes; however, they have drawbacks like higher interest rates and less favorable terms.  

Read on to explore the pros and cons of alternative lenders.

Pros and cons of alternative lenders

Alternative lenders include online lenders, payment processing companies and nonprofit lenders like community development financial institutions (CDFIs). They generally offer more relaxed eligibility, but  come with higher interest rates and shorter terms than traditional loans. 

Pros

• Flexible eligibility requirements.
• May have a faster application process.
• No restrictions on how you use funding.  

Cons

• Higher costs of borrowing.
• Some loans don’t build business credit.
• Shorter loan terms.

Alternative business lending pros

If you’re considering an alternative business finance option, you should know about all the benefits you could get. Here’s an overview of the alternative business lending pros.

Flexible eligibility requirements

Alternative lenders often have more flexible qualification requirements than traditional lenders like banks.  While banks typically require at least two years in business and a credit score of 700 or above, alternative lenders may only require six months in business and credit scores in the 600s. For example, Fora Financial is an online lender that requires six months in business and a 570 credit score to qualify for a small business loan. It offers loans up to $150,000.

May have a faster application process

Some alternative lenders, like online lenders, offer an application process that requires minimal documentation, and can be completed entirely online. They can also offer approval and funding within as little as one business day.

Many alternative lenders also offer the ability to prequalify for the loan. Prequalification helps you see the loan amount and rates you’re eligible for without a hard check on your credit. It can protect your credit while you’re shopping around with different alternative business loans.

No restrictions on how you use funding

Many alternative business finance options don’t require you to submit a comprehensive plan detailing how to spend the funds. This flexibility means you can get approved for funding and use your loan funds for whatever purposes suit your business needs best.

Alternative business lending cons

While the advantages can make alternative business financing options a good choice, you should consider some of the disadvantages as well.

Higher cost of borrowing

Many online lenders charge high interest rates, such as 30 percent or higher, to offset the risk of lending to subprime borrowers or because of the convenience of its fast funding. Other alternative loan types are both complicated and costly, especially if you’re applying for a loan designed for someone with bad credit or a fast business loan.

Other alternative lenders, such as nonprofit CDFIs, can preserve the low rates you’ll find at banks; however, they can have lower loan amounts and may take more time to process. 

Some don’t build business credit

Certain types of alternative financing are not reported to business credit bureaus, so they won’t help you build your business credit score. With any lender, make sure you ask if they report to one of the three major business credit bureaus.  

Shorter loan terms

To offset the risk of lending to startups or borrowers with bad credit, alternative lenders may offer shorter loan terms — typically three to 18 months. Repaying a loan in a shorter amount of time may consequently require a more aggressive repayment schedule — sometimes weekly or even daily payments. Short repayment terms can make it difficult to stay on top of payments, and put your business in a bad cycle of debt.  

The bottom line

Alternative lenders can be a viable option if you are struggling to qualify for traditional funding, but they come with drawbacks like higher borrowing costs and shorter loan terms. 

You’ll want to consider multiple options that you’re eligible for and prequalify with the lenders if possible to compare loan offers.

Frequently asked questions

• What is alternative business lending?
  

  Alternative business lending is a type of business finance secured from sources other than a traditional bank or credit union. These can include online bank lenders, peer-to-peer financing, crowdfunding platforms, invoice factoring companies or merchant cash advances.

• Why is alternative lending important?
  

  Alternative lending is important because it gives businesses a way to secure funding when they normally wouldn’t qualify for a business loan from a bank or credit union.

• What are the disadvantages of alternative lending?
  

  The disadvantages of alternative lending include higher costs of borrowing, no building of business credit in some cases, shorter loan terms and required research to find loans.