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Peer to Peer Lending: A Smart Funding Source for Your Small Business?

by Vinay Jain Peer to Peer Lending: A Smart Funding Source for Your Small Business?

Welcome to the age of the “peer to peer economy.”

Technology has made it possible to instantly match people looking for a service with people willing to provide that service. We’ve gotten used to using Uber instead of taxis and Airbnb instead of hotels. What about turning to the peer to peer economy to borrow money for your small business? 

Peer to peer lending is a bigger deal than you might think. The two leading “P2P” lenders have together funded nearly $10 billion in loans. While most P2P loans are for personal use, they can be applied toward small businesses too.

How it Works

A P2P lending platform connects people who are looking to lend money with people looking to borrow money and makes money by charging each a fee. Borrowers apply for a loan online and their credit is checked. There’s a screening to make sure that they meet the baseline credit history criteria required by the platform. If they pass that screening, then they’re assigned an interest rate based on how much of a credit risk they are. Higher-risk borrowers, who are more likely to default, are slotted into a higher interest rate bracket. Interest rates range from about 6 to 35 percent. The borrower pays an upfront fee and a portion of their interest to the P2P lending platform.

Lenders deposit money into their investment account and get repaid over time with interest. They allocate their money by choosing among the many borrowers seeking money on the platform. They can seek out higher-risk borrowers, who pay a higher interest rate but also default more often (causing the lender to lose their investment) or lower-risk borrowers, who pay less interest but are most likely to pay back the loan. A key way lenders reduce their risk is to make small loans across many borrowers, minimizing the downside if any individual borrower defaults. Lending Club, for example, allows individual loans as small as $25, so if you have $10,000 to invest, you can spread it out among as many as 400 borrowers.

The lender can see anonymized credit information about each would-be borrower so they can make an informed decision about whether to lend to them. There are also auto-invest options, where the lender can set a target level of interest and risk and specify the size of individual loans and the platform will allocate interest levels accordingly. The platform charges the lender by taking a bit of the interest.

Why it Might be for You

One of the most attractive things about P2P lending as a borrower is that you might be able to get a loan that a traditional bank would have denied you. Even if you or your business have a checkered or short credit history, P2P lenders with a higher risk tolerance could be willing to give you a shot, often at lower interest rates than, say, what you would pay on a credit card balance.

If you have good credit, P2P lending might also be an attractive choice. Because these P2P platforms operate entirely online, with no physical branches, they have low overhead and can pass the savings onto the borrower.

Options to Consider

Lending Club is the largest P2P lender, and they have a small business product that issues loans up to $300,000. Prosper is also a big player in the space, although they don’t loan directly to businesses. Instead, you apply for a personal loan and use the money for your business. This can be an attractive option when you’re starting a new business and it doesn’t have the established credit history required for a bank loan.

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It would have been hard to imagine ten years ago that there would be an efficient and cost-effective way to bypass banks and borrow money directly from other individuals. And yet, harnessing the power of technology, that’s exactly what P2P lending has done. Take a minute to go online and get an interest rate quote — see how it ranks against your other options.

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Vinay Jain

As Chief Legal Officer, Vinay serves as Shake's general counsel, is responsible for the company's legal contracts and content, and leads efforts to educate consumers and small businesses about the law.

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