First Small Business Truth-in-Lending Act Passed in California

If we told you a new law now requires lenders to tell small business loan applicants the annualized rate they’d pay for financing, you might be surprised that it wasn’t already standard practice.

That new law came from a bill known as CA SB 1235 which received overwhelming bipartisan support. Aimed at adding transparency in the small business loan market, the new law will doubtless be followed by lawmakers and small business owners outside California as it is rolled out.

In an email interview, LendingClub’s director of public policy, Louis Caditz-Peck provided Small Business Trends with a summary of the bill’s origins and objectives. He also discussed how it ultimately can be a great example of integrity and a win-win for lenders and borrowers.

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Transparency: Small Businesses Deserve It

Small Business Trends: How does this new financial regulation impact small businesses?

Louis Caditz-Peck: For the first time, small business owners can expect finance companies to give them the full story about the price of the loan. This law is just in California so far, and won’t be implemented for a while yet, but here’s why it’s so important:

You may not realize that small business finance companies aren’t required to tell you the rate you would be charged in a way that allows you to make fully informed comparisons between options. We’re all used to comparing rates for credit cards, auto loans, mortgages, and other consumer loans. But the Truth in Lending Act, which requires finance companies to tell us these rates, doesn’t apply to small business loans. And today, many small business financing providers don’t disclose the all-in interest rate, or APR.

At LendingClub, we saw that many of the small businesses coming to us had already taken on other loans or cash advances without realizing how expensive those loans or advances really were. In many cases, they had been quoted something like a “20% rate” without realizing that this wasn’t an all-in interest rate, and that the actual interest rate was 57%. It’s no fault of a small business owner for not realizing that 20% wasn’t the actual APR. The fact is, it’s hard to calculate the actual APR if it’s not disclosed. But APR is the only effective way to compare the prices of loans with different rates and terms.

The bill, SB 1235, has now become the first law in the country to require fully transparent disclosures. It passed with big bipartisan support—72-3 in the California Assembly and 28-6 in the Senate. It’s been hailed as one of the most important borrower protection laws since Dodd-Frank. And it’s already being copied by other states.

The law now tasks the California regulator, the Department of Business Oversight, to set disclosure standards that give small business owners the transparency they deserve, without impinging on any responsible business practices. And it will be up to Department of Business Oversight to get it right.

Small Business Trends: What was the opposition to the bill? At face value it’s hard to imagine anyone opposing it.

Louis Caditz-Peck: You’re absolutely right. Well, small business financing APRs can be quite high—50% is common, and it goes as high as 350% from what we see, though these rates are often not disclosed. Some companies may have preferred to continue not disclosing rates this high.

Merchant cash advances and similar products need to make some assumptions when calculating an APR. Some already calculate and disclose it anyway, and some don’t feel comfortable making these assumptions. The new law requires the regulator to provide guidance on how these assumptions should be made, so that finance companies don’t need to worry that they’re not doing it in an approved way, and so small businesses can count on the transparency they need.

Small Business Trends: What was LendingClub’s role in the creation of SB 1235?

Louis Caditz-Peck: Well, the legislation was inspired by the Small Business Borrowers’ Bill of Rights , which called for transparency standards like these and was created by a group of nonprofits and fintech companies that came together to do something about the irresponsible lending we were seeing. Our partners we work with in that are the Aspen Institute, Funding Circle, Accion, Opportunity Fund, Small Business Majority, and others, and it’s grown to represent over 90 organizations.

Now, the need for small business financing transparency legislation has become widely recognized. It’s supported by Federal Reserve research, many regulators, groups like the Bipartisan Policy Center, and as many as 8 of 10 small business owners by the polling.

To pass this legislation, the Small Business Borrowers’ Bill of Rights group expanded to include over 500 fintech companies, nonprofit small business lenders and support organizations, and community groups and advocacy groups. It’s pretty exciting when industry and nonprofits get together on the same side to solve a problem. Democrats and Republicans both got on board, because everyone could see it’s the right thing to do for small businesses. And now small businesses will now have the information they need to make informed decisions about the cost of their financing for themselves.

Images: LendingClub

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