Rule of Law - January/February 2010
Avoiding Pitfalls of P2P Lending
by Diane Taing
Small business owners struggling to obtain financing in the wake of the credit crunch are turning to a less conventional resource: peer-to-peer (or P2P) lending networks. Peer-to-peer Web sites allow people to lend money to each other without any involvement by a bank. As a result, some small business owners receive loans more easily and with lower rates than they would from traditional lenders. But this type of loan is not without its drawbacks. Advance research and planning will help you avoid some common pitfalls of peer-to-peer borrowing.
Take a hard look at your finances
With peer-to-peer lending, it’s important to evaluate your current financial situation. Otherwise, you might end up making a bad situation worse. Calculate how much money you need to borrow and what you can afford to pay each month. Peer-to-peer loans typically have to be repaid within three to five years, meaning that monthly payments can be higher than those on loans from traditional lenders with longer repayment periods.
A peer-to-peer loan is considered consumer debt and will be reported on the borrower’s credit report as a personal loan, even when the loan is used for business purposes. Peer-to-peer sites may report late payments and defaults to credit bureaus, which will hurt your credit score and make it difficult to obtain loans in the future. As with many other types of loans, you may also have to pay additional fees for delinquent payments.
Set realistic expectations
Peer-to-peer sites generally require borrowers’ credit reports and establish minimum lending credit scores. For example, prospective borrowers at Lending Club must have a FICO score of at least 660 out of 850. The site then rates borrowers based on their credit score, other information reported by consumer reporting agencies and the requested loan amount. Lenders can look at the ratings, along with borrowers’ debt-to-income ratios, in deciding to whom they will lend. Although "soft" information about a borrower--for instance, a personal story--can be influential, a borrower’s credit history and existing debt will undoubtedly play a significant role in lending decisions on any peer-to-peer site.
Check your credit score and be realistic about the rate you want or expect to receive. Asking for rates that are too low relative to your creditworthiness and risk may reduce your ability to get full funding for your loan, or any funding at all. Also keep in mind that while it is possible to get funding quickly, it can take longer than you might hope. As peer-to-peer lending grows in popularity, both the demand for loans and the number of attractive borrowers participating in social lending networks will increase. Lending Club states that funding can take from a few days to two weeks.
Know the terms of the loan
Before accepting a peer-to-peer loan, read the loan agreement carefully to ensure you know and understand the loan’s terms, conditions and rates. In addition to the agreement itself, peer-to-peer sites typically have a FAQ section that explains the rules, fees and risks of borrowing. Consult with an attorney before signing the loan documents if you have any doubts.
Choose a peer-to-peer site that best suits your needs
Peer-to-peer sites are not all equal. They have different platforms for delivering services, different borrowing requirements and different loan terms. Curtis Arnold, co-author of Complete Idiot’s Guide to Person-to-Person Lending (Alpha, 2009) and founder of CardRatings.com, emphasizes the importance of doing the research. "All sites have their own unique aspects, and as this industry really starts to grow, I predict that you’re going to find more niche sites," Arnold says. "As a borrower, you need to figure out what differentiates the sites."
3 Peer-to-Peer Lending Sites to Consider
1. Prosper: Prosper is a peer-to-peer site where borrowers request the amount they want to borrow and set their maximum interest rate. Lenders view summaries of borrowers’ credit history and any personal notes that they choose to write about themselves, their business or how they will use their loan. Then, lenders bid to fund loans, which can drive down borrowers’ interest rates.
2. Lending Club: At Lending Club, borrowers may apply for fixed-rate loans of up to $25,000. Potential borrowers fill out an online application and receive an approval decision from the site. Approved borrowers are presented with several loan options from which to choose. Once the borrower selects the desired loan, it is posted on the site to gain funding from lenders.
3. Virgin Money: Virgin Money is a peer-to-peer site that facilitates lending between borrowers and lenders who already know each other. In other words, the site structures and manages loans that are made between family members, friends and associates. Those looking to document an informal loan arrangement can do so through this site.