Why do loans cost what they do?

A prudent small business will price for its products or services based on the (a) input costs of creating that product or services (supplies and materials), (b) cost of running the business (operating expenses), and (c) profit. The same goes for a lender but in a slightly different form. Here are the material inputs that go into how a lender will price a loan:

  1. Loan Write-Off Expectations: Lending is a risky business. For every $100 a lender lends to its borrowers, some of those some of those dollars will never come back because the borrow has material payment trouble. For example, well-secured real estate loans tend to have minimal loss rates (less than .50%). Small business loans, on the other hand, are very risky. The average historical default rate of small business loans is ~ 10 – 15%! No borrower thinks that he or she will default, but unexpected events happen.
  2. Expenses of Finding a New Customer: It costs a lot of money to find a new customer whether its through marketing and advertising or through a partnership you have with a referral partner. This is a big expense for lenders.
  3. Expenses of Managing Customers: Similarly, it also costs a considerable amount to administrate loans which include everything from payment processing, to reporting, to managing collections for bad loans, to compliance, accounting, and legal costs.
  4. Cost of Capital: And then there is the cost of capital, the money that is lent to a borrower doesn’t come out of thin air. A third party has to either lend that money to a firm like ours or invest that money in our equity capital base. Cost of capital is promised of two elements:
    1. Funding costs – banks have a HUGE edge here as they are funded with low cost deposits. A lender like us must borrow from banks and other institutions
    2. Shareholders return requirements (cost of equity) – Shareholders expect a certain amount of RETURN for the RISK they take in certain business. If a form of lending is perceived as high risk, shareholders are likely to require a higher rate of return on their investment for the risk taken.

Summary:

Running a lending business is an expensive proposition. We have to manage risk, knowing that some of our customers will not repay, we have to manage our expense base efficiently and we have to achieve enough profit to meet expectations of those that provide us with capital.

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About Fundation

Fundation combines the benefits of a bank loan with the ease and efficiency of an online lender. We offer conventional loans with competitive rates to businesses with varying credit profiles. Our technology allows us to deliver capital in as few as 3 business days through streamlining the collection and evaluation of customer information and conducting the majority of the lending process electronically. As a direct lender, we use our own capital to originate and hold the loans we make, so that we can focus on building relationships with our customers. Our dedicated customer relationship model enables us to understand each unique borrower’s business. This level of service, coupled with our best-in-class products, is why many of our customers come back to us repeatedly for more capital.

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