Understanding Peer-to-Peer Lending for Small Business

by Robert Moskowitz

2 min read

Whether you need more cash for your operations or have excess cash you’d like to see earning higher interest rates, peer-to-peer (or P2P) lending may be an attractive option. P2P lending pairs individual borrowers (with proven credit histories) with private lenders who make significant loans, often at favorable rates, without involving a bank as an intermediary.

It’s a growing trend. “Market leaders Prosper and Lending Club have been responsible for the investment of more than $1 billion into the accounts of American citizens and their ventures,” Lewis Humphries of Investopedia reports. “It is also estimated that traditional banks in the U.S. are now responsible for just 25 percent of all lending.”

P2P lenders eliminate the need for small-business owners to kowtow to financial institutions, which in recent years have been notoriously reluctant to lend money to entrepreneurs at competitive rates. P2P lenders match flush investors with low-risk borrowers. The formula works: Prosper’s activity has doubled in the past 12 months and shows no sign of reaching a plateau; the same goes for Lending Club.

Good for Lenders

P2P lending is a good deal for people who have excess cash. Because no bank is involved in the loan, transaction costs need not cover expenses like high-profile advertising, federal deposit insurance, government licensing, or maintaining executive salaries, branch offices, and layers of administrative overhead. As a result, P2P loans can be priced more attractively for lenders and borrowers at interest rates that wouldn’t wash in more conventional scenarios.

Instead of putting money in a bank account that earns 1 percent, or a CD that earns 3 percent, a lender can work within the P2P system and earn 6, 8, 10 or even 12 percent on the same amount of cash.

Meanwhile, the risks are negligible. One reason for this is the careful vetting of borrowers. Another is that lenders can distribute their money across multiple loans, which greatly limits the damage that could be done to their investment capital if any single borrower defaults.

In addition, P2P lenders in the U.S. are required to register their loan offerings under the Securities Act of 1933. As a result, the promissory notes are more transparent and thoroughly documented, and a secondary market allows lenders to sell their loans to other investors, if they wish to do so.

Good for Borrowers

On the flip side, P2P borrowers can quickly and easily obtain an unsecured personal loan for the capital they need at favorable interest rates.

Instead of paying 10 percent for a collateralized loan or 15 percent or more for a credit card advance, highly qualified business borrowers can pay as little as 6 percent (as of Feb. 4, 2013) on loans, possibly less. Even with the add-on fee for writing the loan, these rates help make borrowing from peers less painful than working with banks.

To see what rate you might pay, visit the websites of various P2P lenders’ websites, including Lending Club, Prosper, and Peerform. Just provide a bit of basic information and these sites will quickly provide you with a quote.

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