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The State of Online Business Lending: The Fed’s Small Business Credit Survey

By Roy Rasmussen Reviewed By Mike Lucas
By Roy Rasmussen
By Roy Rasmussen Reviewed By Mike Lucas

Each year, the Federal Reserve conducts the Small Business Credit Survey (SBCS). Here’s what the latest SBCS data says about online lending.

We’ll cover survey findings about what kinds of companies use online lenders, what the online lending application experience is like and what kinds of credit outcomes online borrowers encounter.

Background to the SBCS Update on Online Lender Applicants

The SBCS is an annual collaborative effort of the 12 Reserve Banks of the Federal Reserve System designed to provide policymakers, researchers and service providers with key information on small business financial needs, decisions and outcomes. 

Toward that end, the survey asks small business owners to describe their current business climate, recent financial needs and credit experiences.

In 2019, the Federal Reserve used its 2018 survey data to produce an update on online lender applicants. This was done in light of the growth of online lending in recent years. 

Online lenders use data-driven technology and processes to provide financing services such as underwriting, pricing, servicing and fund delivery. They offer various products to borrowers, such as long-term loans, short-term loans, lines of credit and merchant cash advances.

In the years previous to the survey, use of online lenders for such services grew rapidly. The share of financing applicants who sought funds from an online lender increased from 19% in 2016 to 24% in 2017 to 32% in 2018. This trend has continued to advance since the survey was conducted. An annual survey by financial firm JPMorgan Chase released in January 2021 found that in 2020, 44% of small businesses explored online lending, while 25% took an online loan. Over half of small businesses said they would consider an online loan if they needed capital in 2021.

Studying the Online Lending Trend

The Federal Reserve produced its report to study this trend. The report focused on data about the characteristics, financing experiences and credit outcomes of 3 groups of borrowers:

  • Those who applied only at online lenders
  • Borrowers who applied only at conventional lenders such as banks and credit unions
  • Those who applied at both online and conventional lenders

The report distinguished these groups in order to contrast the experiences of borrowers who applied online and those who applied through conventional means.

How Was the SBCS Conducted?

The analysis in the Federal Reserve’s report is based on an annual SBCS survey of companies with fewer than 500 employees administered by the 12 Reserve Banks of the Federal Reserve System. Of 6,614 firms participating in the 2018 SBCS survey, 43% had applied for financing in the past 12 months.

Small business owners participating in the survey were asked to provide information about their business performance, financing needs and decisions and borrowing outcomes. Applicants were grouped based on whether they sought financing from online lenders, conventional lenders or both.

The SBCS survey is based on a convenience sample rather than a random sample, meaning that survey participants were drawn from respondents who were conveniently at hand for researchers. Participating firms were located in the 50 States and the District of Columbia.

The nonrandom nature of the survey makes it subject to statistical biases. To offset this, the sample data were weighted so that the weighted distribution of firms matches the actual distribution of U.S. small businesses indicated by Census Bureau data.

A hand is about to tap on the big “Apply Now” button of a computer tablet screen displaying a web page labeled “Business Loan.”

What Kinds of Firms Use Online Lenders?

The report found that overall, 32% of small businesses sought financing from an online lender during the time period covered by the survey. This contrasted with 49% who sought financing from large banks, 44% who turned to small banks and 9% who applied to credit unions.

Firms which used online lenders were more likely to have several key characteristics, including:

  • Lower credit scores
  • More financial challenges
  • Less profitable business performance

These characteristics help explain the appeal of online financing options, which offer an alternative to businesses which may struggle to meet the criteria needed to obtain financing from banks and credit unions.

Lower Credit Scores

The survey divided applicant credit scores into groups as follows:

  • Low credit risk: Business credit scores of 80 to 100 or personal credit scores of 720 or more
  • Medium credit risk: Business credit scores of 50 to 79 or personal credit scores of 620 to 719
  • High credit risk: Business credit scores of 1 to 49 or personal credit scores below 620

Among applicants with low credit risk:

  • 7% used online lenders only
  • 80% used conventional lenders only
  • 13% used both

Among those with medium credit risk:

  • 17% used online lenders only
  • 46% used conventional lenders only
  • 37% used both

Among those with high credit risk:

  • 14% used online lenders only
  • 38% used conventional lenders only
  • 48% used both

As these numbers indicate, small firms increased their use of online lenders as their credit scores decreased. For both high- and medium-risk applicants, over half sought at least one online lender, in contrast to the preference for conventional lenders among low-risk applicants. This illustrates how online lenders appeal to firms with low credit scores which may face difficulties obtaining financing from conventional banks and credit unions.

More Financial Challenges

Companies which use online lenders are more likely to be facing financial challenges, the survey showed. Firms which reported experiencing financial challenges in the previous year broke down as follows:

  • 86% of firms applying at online lenders only reported financial challenges
  • 71% of firms applying at conventional lenders only experienced challenges
  • 96% of firms applying at both online and conventional lenders reported difficulties

With respect to the nature of the financial challenges which prompted firms to seek financing, companies which turned to online lenders tended to be more likely to seek financing to meet operating expenses. Survey respondents were allowed to list up to 3 reasons for seeking financing. The percentage of firms in each category which sought funding to finance operations broke down as follows:

  • 62% of companies using online lenders only sought financing to meet operating expenses
  • 40% of companies using conventional lenders only needed to cover operational costs
  • 61% of companies using both online and conventional lenders wanted financing to meet operating expenses

These numbers suggest that cash flow can be a major reason for turning to online lenders. The other most common reasons for seeking online funding were expanding operations (44% of companies which used online lenders only and 61% which used both online and conventional lenders) and refinancing debt (29% of companies using online lenders only and 43% using both online and conventional lenders).

Less Profitable Business Performance

Online lending applicants tend to have less profitable business performance than other companies seeking financing:

  • 82% of companies that only use online lenders generate annual revenue of less than $1 million, compared with 58% which only use conventional lenders and 73% that use both
  • 44% of companies which use either online lenders or both online and conventional lenders operate at a profit, compared with 60% that only use conventional lenders

These performance comparisons help explain why companies which seek online lending tend to need money to cover operational expenses.

What Is the Online Lending Application Experience Like?

Online-only lending applicants differed from applicants in other categories in the frequency of their applications, the type of financing sought, the amount sought and the motivation for seeking lenders.

Frequency of Application

Both firms which exclusively used online lenders and those which only used conventional lenders applied for financing less frequently than those which used both sources. Among both of the first pair of groups, 13% submitted 4 or more applications in the previous 12 months, compared with 49% among those using both types of lenders.

Type of Financing Sought

The most popular types of loan products sought by online-only applicants and those who used both online and conventional resources included:

  • Business loans (sought by 53% of online-only applicants and 73% of those who used both types of financing)
  • Lines of credit (30% and 50%, respectively)
  • SBA loans or lines of credit (8% and 31%)
  • Auto or equipment loans (4% and 25%)
  • Merchant cash advances (20% and 21%)

As this indicates, business loans were the most popular loan product among those applying with online lenders.

Amount of Financing Sought

Firms applying for online financing tend to seek lower amounts of financing. Amounts of financing sought by online-only applicants and applicants using both online and conventional sources broke down as follows:

  • $25,000 or less: 33% of online-only applicants and 23% of applicants using both online and conventional resources
  • $25,000 to $100,000: 46% and 38%, respectively
  • $100,000 to $250,000: 16% and 20%
  • $250,000 to $1 million: 5% and 14%
  • More than $1 million: 0% and 4%

As this shows, applicants tend to rely on online lending more frequently for amounts under $100,000. Average lines of credit tend to be $25,000 or less.

Motivation for Seeking Lenders

As mentioned above, applicants tend to seek financing to pay for operations. Consistent with this, when it came to reasons for selecting lenders, online-only borrowers prioritized lenders whom they perceived could provide financing faster (cited as a motivation by 62% of online-only borrowers) and whom they perceived were more likely to approve financing (57%). In contrast, applicants seeking funding from conventional sources prioritized existing relationships with lenders.

This infographic poses this question: What Kinds of Credit Outcomes Do Online Borrowers Encounter? And then it lists: Greater Approval Rates (followed by a thumbs-up symbol); and Lower Satisfaction Rates (followed by a thumbs-down symbol).

What Kinds of Credit Outcomes Do Online Borrowers Encounter?

Credit outcomes for online lending applicants exhibited a few noteworthy trends. Compared with other applicants, online lending applicants received higher rates of approval, despite tending to have lower credit scores. However, satisfaction rates with online financial providers were lower, with high interest rates and unfavorable payment terms generating the largest percentage of complaints.

Greater Approval Rates

Online lending applicants generally received approval more often than applicants to conventional lenders, even when they had low credit scores. Applicants who only applied to online lenders were the most likely to receive full approval for loans, lines of credit or cash advances (63%, compared with 62% for applicants who sought conventional lenders only and 48% for those who worked with both types of lenders). 

Applicants to online lenders only were approved for full or partial funding 93% of the time. But those who applied to both online and conventional sources were approved by online lenders 76% of the time. That is generally higher than approval rates for large banks, small banks or credit unions.

Low credit scores posed less of a barrier for online-only lending applicants. Applicants with low credit risk were approved 94% of the time (compared with 85% for conventional lenders only and 90% for both types of lenders), while those with medium or high credit risk were approved 89% of the time (compared to 57% for conventional lenders only and 68% for both). However, low credit scores were the most common reason for denying credit to applicants to online lenders only (cited in 46% of denials), whereas insufficient collateral was the biggest reason for applicants to conventional lenders only (42%).

Lower Satisfaction Rates

Online lenders received lower satisfaction rates than banks. Satisfaction rates were 35% for borrowers who worked with online lenders only and 30% for those who worked with both online and conventional lenders. This compares with 75% for borrowers who worked exclusively with small banks and 57% for those who worked only with large banks.

Other data pointed to the causes of these lower satisfaction rates. The biggest challenges borrowers reported with online lenders were high interest rates (cited by 53% of respondents) and unfavorable repayment terms (32%). However, complaints about a difficult application process (15%) and long waits (12%) were lower than for other types of lenders and 37% of borrowers reported experiencing no challenges at all with online lenders. These numbers highlight some of the pros and cons of working with online lenders.

Consider Whether Online Lending Is Right for You

The Federal Reserve’s survey collected data about small business loan applicants’ performance, financing needs and credit outcomes. The results showed small businesses seeking online lenders were more likely to have:

  • Low credit scores
  • Financial struggles
  • Business performance issues

These conditions often prompted small businesses to turn to online lenders for help with covering operational expenses. Business expansion and debt refinancing were other common motivations for seeking online lending resources.

Small businesses which sought online financing usually applied for business loans and lines of credit of $100,000 or less, with $25,000 or less more common for lines of credit. Applicants prioritized lenders who could provide fast financing and high approval rates.

Online lenders delivered higher approval rates than other lenders. But this is often with a trade-off of higher interest rates and less favorable repayment terms. However, over a third of online borrowers reported no concerns about these issues.

Clearly, the quality of your online lending experience can vary significantly based on your situation and your lender. Fast Capital 360 uses digital technology to match small business applicants with lenders who fit their credit score and financing needs. To see which resources might match your needs, take a few minutes to fill out our free, no-obligation prequalifying form and see your loan options.

Roy Rasmussen Contributing Writer for Fast Capital 360
Roy is a respected, published author on topics including business coaching, small business management and business automation as well as an expert business plan writer and strategist.
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