Peer to peer lending, also called person to person lending, is useful for small businesses as a source of business loans and business credit. As business credit has tightened in the banking sector, small businesses have had to look toward other sources for business loans. Peer to peer financing is one valuable source of financing that has been tapped by small businesses.
Peer to peer lending is simply lending between two individuals. Businesses go to peer to peer lending sites for simple reasons. They can get cheaper and easier loans through peer to peer lending sites than through banks, particularly with the tight lending conditions which companies are currently experiencing at banks. Sometimes, businesses or entrepreneurs can't get loans from traditional lending institutions in the current environment and are forced to use lending sources like peer to peer lending or merchant cash advances.
Who do Peer to Peer Lenders Lend to?
Many of the peer to peer lending sites don't make loans to businesses. However, if a business is a start-up or if an entrepreneur is trying to get a loan to pursue an idea, then they usually borrow as an individual. The only problem is that, then, the loan shows up on their individual credit report and, because it is a debt, may lower their credit score. Peer to peer loans are considered personal debt even when used for business purposes.
How Peer to Peer Lending Works
Peer to peer lending works much like an eBay transaction. Using one of the peer to peer sites like Prosper, you set up an account. Read their guidelines and the types of loans their lenders fund. With regard to Prosper, even though they don't officially fund business loans, you will see that they do state they fund entrepreneurs who want to start a small business. Then, you post the amount of the loan you need and the maximum interest rate you will pay on their online auction site. That's basically all there is to it. You have to have a good personal credit score to qualify for a loan, usually 640 or more.
Your loan request goes into a 7-day auction. Lenders bid on your loan and, as they do, your interest rate may go down. If you change your mind, you can stop the auction.
The interest rate and monthly payments are fixed and there is a one-time closing fee. There is no charge for prepayment. The loan is unsecured, which means no collateral in involved. The term is usually about 3 years. The monthly payments are often automatically deducted from your bank account.
Another peer to peer lender to check out is Lending Club. The terms may vary slightly but the principle is basically the same.
The Cost of Peer to Peer Borrowing
Peer to peer lending for businesses is usually cheaper than borrowing from a bank. Why? The middleman (the bank) is cut out. Banks have overhead they have to pay - buildings, administrative costs and the like. In today's world, banks are also struggling to regain losses they took in the credit crisis which may increase their interest rates. Using peer to peer lending allows you to get the absolute best interest rate because lenders are competing for your loan.
Since most peer to peer loans are fixed rate loans, they can be amortized. You can amortize your own loan using this example.