In life, there are plenty of tried and true examples of cause and effect. Exercise and you’ll get stronger. Diet and you’ll lose weight.
In the world of small business lending, there’s a similar principle in action—find a loan with more paperwork and you’ll get a better rate.
While this might not be an ironclad law of lending, in most cases it’s a highly accurate predictor. Loans with less paperwork require much less due diligence than conventional paperwork-intensive bank loans.
With that in mind, let’s take a closer look at the link between paperwork and loan rates, as well as the specific paperwork requirements that small business owners need to meet when applying for different lending products.
Why Less Paperwork (Usually) Means Higher Rates
Let’s face it—few people, if any, enjoy paperwork. It’s just something we have to plow through to accomplish a larger goal.
So, especially for busy small business owners, the idea of accomplishing a big task without much paperwork seems like a good deal.
When it comes to loans, though, less paperwork is usually a mixed blessing.
The Paperwork Dilemma: Speed vs. Cost
The process of applying for a conventional business loan can be pretty similar to the mortgage application process: there’s an avalanche of documents waiting to be filled out.
This extends the time it takes to process a loan and can force you to spend considerable time and resources tracking down the information you need.
Alternative Lending Moves Faster
For non-traditional online loans, however, the paperwork burden can be far less intense.
Because of this, loan approval can be granted very quickly: 24 hours or less, in many cases. Applicants don’t have to worry about tracking down documents, streamlining the process and making it a whole lot less daunting.
Fewer Documents, Higher Rates
But there’s a cost for dispensing with these paperwork requirements: interest rates are typically higher.
The more detailed and lengthy a due diligence process is, the greater the need for documentation and paperwork. Companies pursue these extended due diligence processes in order to fully vet applicants, making sure they’re worth the risk. If you can pass the test, a better interest rate likely awaits you.
Lenders who don’t pursue thorough due diligence generally uncover less background information about their applicants.
This, in turn, makes these potential borrowers less of a known quantity and more of a credit risk… Which ultimately leads to lower paperwork requirements but higher rates.
Different Loan Types and the Paperwork Loads They Carry
Now that we’ve discussed the link between paperwork and interest rates, let’s take a look at the specific documentation requirements associated with a variety of loans.
Conventional and SBA loans
The sheer amount of documents needed for a conventional bank or SBA loan can be quite intimidating to some loan applicants.
Prospective borrowers are typically asked to provide personal information (educational background, criminal history, names), credit reports, business plans, financial statements, business financials, a resume, bank statements, and legal documents (copies of contracts, leases, business agreements).
As you might imagine, this heavy paperwork load takes quite a bit of time to work through, meaning that conventional loans can take up to 90 days to process.
Unlike conventional or SBA loans, alternative lenders that offer short-term loans have much looser paperwork requirements and faster turnarounds.
In some cases, three to six months of bank statements will be sufficient and you don’t need to have a perfect credit score. On the other hand, they tend to have higher interest rates.
While medium-term loans don’t have the exhaustive paperwork requirements of SBA or conventional bank loans, they do require more documentation than short term loans.
Along with up to six months of bank statements, borrowers are typically asked to provide business and personal tax returns, balance sheets, profit and loss statements and, potentially, year-to-date financials that have been updated within the last few months.
Any business with outstanding receivables can qualify for invoice financing.
Requirements are typically as follows: a sample invoice, proof of existence, and current accounts receivable aging.
Keep in mind that accounts receivable financing companies will look at your credit report and the fees for this type of loan are higher than traditional financing.
Merchant cash advance
Like short-term loans, a merchant cash advance has a very low bar to clear in terms of paperwork.
Three or four months of bank statements will often be enough to process the loan, and you’ll likely be approved in one or two days.
As with other low-paperwork loans, this one comes with higher fees than traditional loans.
As much as we dislike it, paperwork is an unavoidable fact of life—and an important part of the lending process.
How important, though, depends on the type of loan you choose.
If you’re looking for a loan with minimal paperwork requirements, then a short-term loan or invoice financing might be the best choice. But if you’re primarily interested in securing the best rate possible, then fulfilling the much stricter paperwork demands of an SBA or conventional bank loan is probably what you want.
from Fundera Ledger https://www.fundera.com/blog/2016/06/09/paperwork-loan-cost/