Peer-to-Peer Lending (P2P) for Small Businesses

Learn more about this promising loan alternative for small businesses.

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Peer-to-peer (P2P) lending, often referred to as “social lending”, may be a promising alternative for loans for many small businesses. Whether operating existing businesses or starting new ones, many entrepreneurs find it challenging to obtain credit from traditional lending institutions, such as banks.  In some instances, small business owners may lack a track record in their new industry, or past credit problems may hinder their ability to get loans.  Typically owners of small ventures turn to borrowing money from family and friends in their social circle.  P2P lending sites build upon this social circle approach by allowing qualified entrepreneurs to pitch their business proposals and credit needs to an online audience of potential individual or group lenders. As financial matchmakers, it is estimated that up to $5 billion will be loaned through P2P lending services in the coming years. 

Like social media sites, individual borrowers and lenders may set up profiles using screen names to communicate with each other on the site.  Potential lenders browse site listings of each borrower’s purpose for seeking a loan and review interest rates for the proposed loan amounts. One or more individual lenders may agree to fund your loan.  The P2P site helps facilitate the delivery of funds to the borrower and loan payments to the creditors. Under this emerging credit alternative, there are some key issues to think about if you decide to seek credit through P2P lending sites.

  • Recognize that Your Credit History Matters.  Unlike most traditional lending institutions, you are normally not required to provide collateral for P2P loans.  Because these loans are unsecured loans, your credit history plays a key role in whether or not you qualify for P2P lending.  Most social lending sites ask individuals to complete an application to help verify borrower identity, such as U.S. citizenship, to allow access to an applicant’s credit score, and to determine a proprietary credit rating system.  These sites normally will screen out applicants who do not meet a pre-determined credit score or rating.  Although P2P lending sites do not expect you to have perfect credit, if you have a poor credit history, you may not even qualify to request a loan on these P2P sites.  If you had past financial troubles, consider improving your credit history before applying to these sites.
  • Write a Strong Business Pitch for Your Loan.  Conventional lending institutions will require a detailed business proposal as part of a detailed loan application process.  Aside from credit information provided to P2P service providers, borrowers offer a brief description of their business purpose or need for the requested loan amount.  In addition, some borrowers will discuss their prior track record in paying back previous P2P loans to show their financial responsibility. The more compelling, professional, and clear your pitch for the funds coupled with strong creditworthiness, the more likely you are to attract potential P2P lenders.
  • Examine the Borrower Fees that P2P Sites Charge.  Unlike other social media sites, P2P lending sites charge various fees to qualified borrowers.  These P2P sites typically provide diverse services, including posting your loan request, verifying your identity and income, rating your creditworthiness, hosting online profiles and party communications, and distributing your loan payments amongst applicable lender accounts.  As a borrower, you may have to pay a variety of fees, such as a loan closing fee based on a specified percentage of a loaned amount, an insufficient funds fee for failed payments, and late fees for overdue loan payments.  Be sure to evaluate the site’s fees and compare them to conventional lenders’ fees if you plan to use P2P lending sites.
  • Be Sure You Understand Your Loan Terms. In the social media environment of P2P sites, you may enjoy chatting with potential lenders about your business strategies and goals.  But keep in mind that these P2P lenders hope to earn profit from your loan which is greater than what they might earn from other traditional investments.  Some P2P sites allow interest rates to be determined in an auction-style manner while others set interest rates based upon your credit score.  Loan repayment periods can vary, often running from 1 to 3 years or 3 to 5 years.  Whatever loan agreement you enter into, make certain you thoroughly understand its terms as well as your obligations to your P2P lenders.
  • Make Timely Loan Payments.  Like any conventional loan, it is important to make timely payments on your P2P loans.  Your failure to make timely payments may result in additional fee assessments and reduce your chances of qualifying for future P2P loans.  Furthermore, defaulting on your loan may harm your credit history and damage your future credit score.  Despite the informal, convenient nature of these sites, it is important to recognize that these loan agreements are contracts that need to be properly performed. 

To learn more, you may want to take a look at two major P2P lending sites, Prosper, http://www.prosper.com, and Lending Club at www.lendingclub.com as starting points as you evaluate potential P2P lending sites on the Web. 

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