Watch for these four clues to peer lending scams and avoid high-interest small business loans.
So you need money and the banks just aren’t lending. As if someone is listening, you get an email offering loans of up to $50,000 with no credit check.
Is it a lifeline from above or one of those too-good-to-be-true warnings?
There’s a lot of information on the ‘net about risks to investing in peer loans but content around the risk of peer lending scams and small business loans isn’t easy to find. I posted three borrower risks in peer lending in December as a way to highlight general risks to borrowers but didn’t get into warning signs of outright scams.
With the increase in peer lending every year, you can bet that scammers are looking for unsuspecting borrowers and small business owners to take advantage of them in clever peer lending scams and high-interest loans.
It’s too bad because these few p2p scams are going to give peer lending a bad name and ruin what could be a great opportunity for many borrowers.
Understanding the warning signs of peer lending scams will go a long way to avoiding being the victim.
Warning Signs for Peer Lending Scams
Outright peer lending scams are not yet as common as hearing you are the sole heir to the throne of Nigeria but they are becoming more popular. The scams I’ve seen range from sky-high interest rates that break the law to just plain theft.
While not all peer lending scams will be easy to spot, there are some things that should alert you to a peer lending rip-off.
- Legitimate peer lending platforms do not ask for an up-front payment. This should be fairly obvious. Would you give the bank $1,000 for them to give you a loan? Asking for fees to be paid before the loan is actually illegal in the United States and Canada. Peer lending sites like Personalloans.com charge a fee of between 1% and 5% of your loan amount but you only pay this fee if your loan is fully funded.
- Do not use money wire services like Western Union for your loan. Loans should go through your bank account through direct deposit or wire. Going through wire services makes it harder to track who is actually getting the money and impossible to get the money back if you are scammed. Legitimate peer lending platforms work directly with your bank account and through the Federal banking system.
- Peer lending scam artists will sometimes guarantee you a loan or quote a rate before checking your credit or application. No legitimate business would do this. How can you guarantee someone a loan or a rate without knowing who is receiving money? The scammers do it because you’ll never receive the money anyway. Real peer lending and personal loan sites like Lending Club will do a soft pull of your credit to offer an interest rate.This credit check doesn’t hurt your credit score and the site won’t do a ‘hard’ check until you accept the terms of the loan.
- You should always check with your state’s Attorney General’s office before signing any loan documents. Anyone offering a loan must be registered in each state where they do business. If they aren’t registered, it’s illegal for them to offer loans and could be a peer lending scam.
The Federal Trade Commission posts guidelines and examples of peer lending scams on its blog. It is an interesting read and will help you be on the lookout for credit & loan scams.
Just because a company has a website and people that talk like bankers when they answer the phone, doesn't mean the offer is legitimate. Peer lending scams prey on those that have few other options and rely on the fact that a large percentage of people will not verify promises made over the phone or on the site.
The authorities actively search the internet for scams but it’s a huge World Wide Web and may be difficult tracking down foreign shysters. When in doubt, check out our resource guide for best peer to peer lending websites including the fees and features on each site. I’ve used several of these p2p sites for loans and investing and they’ve all been check out as legit.
Small Business Loan Risks
Even if you avoid being scammed in a peer lending con, there's another risk in peer lending for which you need to watch.
Most business owners would not think about going to a payday loan company for a one-week personal loan with annualized interest rates as high as 500 percent. So why would that same business owner take out a short-term peer lending business loan at astronomically-high rates?
“But I need quick funding for short-term expenses, and I know my business idea is a great one,” is the response I usually get when I talk to small business owners. They get excited about an idea and think rates don’t matter if they can make the idea work.
The problem is that most peer lending business loans require several years in business and current sales. If you don’t qualify, it could force you into shorter-term loans at high interest rates.
Do a Google search for small business peer lending and you’re likely to come across a post by OnDeck Capital titled, “OnDeck Capital Targets Businesses Banks Won’t Touch.”
The company is one of the largest online lending platforms for business loans and even sold stock on the New York Stock Exchange last year. On its IPO date in December, the company was worth $1.3 billion and it has dispersed more than $1.7 billion in loans to 2014.
The company surely isn’t a peer lending scam and the stated interest rate of between, “18 percent and 36 percent,” displayed on the site isn’t too high. What could be wrong with funding my business loan on a quick six-month loan if it means I can get my expenses covered?
Interested, I looked a little deeper and found a copy of a business loan offer on Google images and posted on Fundastic.
I have a few problems with this offer letter and am a little surprised the company is able to get it past regulators. The offer discloses that the interest rate (20%) is not the actual annualized rate and it turns out it’s just the simple division of interest over the loan amount ($4,000/$20,000).
The annualized percentage rate (APR), the actual interest rate you end up paying, is required to be disclosed on mortgage and credit card loans. The requirement hasn’t yet made it to peer lending business loans but most other platforms already disclose it.
Let’s look at the real interest rate you would pay on this loan, under the terms offered. Plugging in the $20,000 loan with daily payments for 126 days and a $500 finance charge into an APR calculator yields a rate of just under 93% on an annualized basis. It may not be the 500% annualized rate at payday lenders but that is still incredibly high.
Besides the extremely high rate, I almost fell out of my chair when I saw that the 125 payments were on a daily basis. I guess this wouldn’t be a problem if you already got strong sales on your business but it is still a little scary to have to make a loan payment every single day.
Miss a deposit one day and you’ll end up paying missed payment fees to the lender.
OnDeck is not the only short-term business lender, just the most visible. Resist the temptation to let your excitement over a business idea get the best of you. Understand the true cost of a short-term loan and do not pay interest rates that could send your business into bankruptcy.
You are much better off getting a longer-term personal loan at an annualized rate around 20% and paying it off early. Most peer lending platforms do not charge early payment fees so you can pay a loan off as soon as possible.
The largest personal loan peer lender, Lending Club, has been making business loans for more than a year and just lowered its minimum loan amount to $5,000 for businesses. Interest rates are much lower than short-term lender options so I would explore this option first.
If you don’t qualify for a business loan, apply for a personal loan instead. The interest rate on the business loans I’ve seen is not much different from personal loans and it’s much easier to get a p2p personal loan. Neither will usually require collateral and you can borrow up to $36,000 for most personal loans.
Understanding what to watch for in peer lending scams can help you keep from getting taken to the cleaners. Stepping back and looking at the true cost of a loan can help from falling into a cycle of high-interest short-term loans.