The Pros and Cons of Small Business Peer-to-Peer Loans
If you’ve had trouble getting approved for bank loans to grow your business, you don’t need to throw your expansion plans in the garbage. There may be another solution: peer-to-peer lending.
Much like Kiva, the online non-profit platform that allows individuals to make microloans to help finance entrepreneurial ventures in developing countries, there are now services that allow groups of individuals to make loans to other individuals or entrepreneurs within the United States, typically for amounts totaling $25,000 or less. Some of the better-known peer-to-peer lending platforms include Prosper, Zopa, and Lending Club, and new ones are popping up all the time. But is this a good way to finance your business? Consider the pros and cons.
Pro: The process can be completed quickly. Loan applicants are either approved or denied instantly, and the loans are typically fulfilled within two weeks or less. Bank loans typically require far more documentation, and can take longer to approve or deny requests.
Con: Peer-to-peer loans are not subject to the same financial regulations as banks, so the loan terms may not be as favorable. These microloan platforms are relatively new, so there are few policies in place to protect the lender. Before signing any contract, ask your accountant or lawyer to look over the terms for any red flags.
Pro: Interest rates are typically lower than bank rates. According to TheStreet.com, annual percentage rates (APRs) on peer-to-peer loans typically average 11% on three-year loans and 14% on five-year loans, as compared to 15% to 24% at most banks. However, some peer-to-peer loan rates can be very high. Shop around.
Con: Peer-to-peer loans can hurt your personal credit score. Currently, none of the peer-to-peer lending networks are set up to make loans directly to small businesses. Instead, you must apply for the loan as an individual, which can hurt your credit score and make it much more difficult for you to secure future bank loans or obtain credit from vendors.
Pro: They are less discriminate than banks. Since the economic collapse in 2008, banks have cut way back on giving loans to startups and small businesses. In peer-to-peer lending platforms, even individuals who have bad credit ratings may be approved for loans, thanks to the sites’ collective lending approach. Because individual investors grant microloans to each borrower, no one bears much personal risk if the borrower defaults.
Con: They are less discriminate than banks. Yes, this is a positive that can also be a negative: The fact is, in many cases, banks deny loan applications because there’s a good chance the borrower won’t be able to repay the loan amount within the necessary time frame. Before making the decision to take on substantial debt, sit down with your accountant and take a good look at your financial situation to see whether you’ll really be able to pay off the loan. If you’re not certain, don’t do it: Gambling on a loan could have dire consequences for your personal credit score — and for your business.
For more about peer-to-peer lending (including firsthand perspectives), check out this companion story.