The internet has revolutionized the way business is done. Everyone now has instant access to nearly everything, all the time. Barriers that once existed such as distance and know-how have been radically narrowed with the growth of the online world.
Business funding has been particularly altered by the world-wide web. The ability to connect everyone, quickly process massive amounts of data and determine creditworthiness in an instant has opened up entirely new avenues for business and individuals to obtain funding.
The Introduction of Online Peer to Peer Lending
One new form of business and personal lending that could not have existed prior to the internet, is peer to peer lending. Peer to peer loans are loans that are funded by other individuals. Obviously, person to person lending has been around from the start of commerce. Personal loans made to individuals and businesses are nothing new. However, these loans were made to family and friends as no sensible lender would extend a loan to a stranger. This is the huge difference between the current wave of peer to peer loans and person to person personal loans made for centuries.
The internet combined with the latest in financial technology has enabled individuals to safely create loans directly to strangers for business or personal purposes. Lenders are very interested in making these loans since they often pay higher interest rates than achievable elsewhere and businesspeople seek out peer to peer loans since the criteria for approval can be easier than traditional bank loans.
How to Peer to Peer Loans Work
Technology permits borrowers to work straight with other people who have the capital to lend. Borrower fill out lending applications at peer to peer lending facilitators. The facilitators then aggregate deposits of those with the capital to lend. Finally, borrowers and lenders are matched through the facilitator based on the credit criteria chosen by the individuals who have opened accounts with the facilitator.
The better the borrower’s credit and other metrics means the safer the loan for the lenders. At the same time, the lower the borrower's creditworthiness, the higher the risk for the lender. This means the loans are aggregated by credit worthiness with the lower-rated, riskier loans having higher interest than those with less calculated risk. Lenders willing to accept high risk will earn higher interest and, at the same time, risk-adverse lenders make less. Once the borrower receives the loan, payments are automatically taken from the borrowers checking account, making the process easier for everyone involved.
Now that we understand how peer to peer lending works, is it the right thing for your business? Let’s take a closer look.
Is Peer to Peer Lending Right for Me?
Just like a bank loan, peer to peer lending requires a credit check. While many other factors are taken into consideration, generally, a personal credit score in the mid 600’s is the minimum to qualify. Next, every state has its regulations regarding the legality of peer to peer lending. Some states allow investing in peer to peer loans, but not taking out a loan from a peer to peer firm and vice versa. Be sure to check the laws in your state before considering going the peer to peer route for a business loan.
Don’t forget the interest rate and fees when applying for any business loan. Peer to peer loans can boast interest rates as low as 7% for those with stellar qualifications. However, rates can skyrocket to over 35% for those that the peer to peer firm considers on the riskier side. Make sure that you know your rate before you commit to a peer to peer loan.
On top of the interest rate, peer to peer loans usually, carry fees of 1 to 5% that is taken off the top of the loan. In other words, if you borrow $20,000.00 and the loan fee is 5%, your net loan proceeds will be $19000.00 with the $1000.00 difference representing the 5% loan fee.
Peer to peer loans can be a great option for business owners. Prior to getting a peer to peer loan, it is critical to know if peer to peer lending is legal in your state and to have a good idea if your credit score qualifies. Then, once you determine if you can take out and qualify for a peer to peer loan, make sure you consider both the loan fee and interest rate before committing. After considering all of these factors you can be confident in your decision of whether or not peer to peer lending is right for your business.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.