What is Peer-to-Peer Lending?

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Anyone who’s taken a loan out knows that the name of the game is interest. You want the lowest interest rate possible, and the bank wants the best return on its investment. This is not necessarily because the bank is greedy or trying to take advantage of you. The fact is that maintaining a financial institution is costly, and processing a loan comes with risks and expenses that must be covered via interest to make it worth the bank’s while to give the loan. It’s just business…

But what is the bank really doing here? It’s taking the funds of other people and lending the funds to you at a premium. What if there was a way to cut the bank out altogether, and borrow from the people directly? Well, that’s exactly what peer-to-peer (P2P) lenders are doing, and it’s catching on.

How do P2P loans work?

Think of it like Kickstarter or Indiegogo, except instead of giving “rewards” to your funders, you give them returns on their investments. The lenders reap the benefits of higher interest rates than a savings account or CD would yield, while borrowers can potentially qualify for lower interest rates than they’d find for similar loans at a bank, and way lower interest than credit card debt, with a simpler application process and quicker funding than is status quo for traditional loans.

Typically the lending company will review your loan application and decide whether or not you would be a good fit for this type of platform. If approved, they will classify your loan based on the risk it poses to funders, and offer you rates and fees that correlate to this risk level. The riskier the investment, the more money the peer lenders will want to get in return, leading to higher interest rates for you. Remember, if you default on your loan these people will lose their money. They’re really hoping that you don’t.

The potential lenders may be given some basic information about you and your loan before they commit to forking over the cash. This process is anonymous, so you don’t have to worry about your private personal or business finances becoming public information.

Who are P2P loans for?

Most P2P loans are personal loans, but some lenders have separate sectors for small business loans as well. One example of this is LendingClub, which provides individualized customer support for its small business borrowers – a feature not offered to those seeking personal loans. The application process is basically the same, although some additional documentation may be requested.

In terms of small business P2P loans, there are two main advantages over traditional loans:

  • Simpler, more convenient application process than a traditional loan provides. Business loans from traditional sources often come with lengthy application processes, and may include things like business visits. P2P loan applications, on the other hand, can be done at home in your pajamas and generally don’t even include a phone conversation. The whole thing is done on the web.
  • Faster approval and funding. With a traditional small business term loans, it will take much longer to get funded. P2P loans are viable options for businesses that need cash fairly quickly.

There’s one important caveat, however:

  • P2P loans are not for those with bad credit. While the internet may seem like the wild west, P2P lenders are actually fairly conservative and risk-averse. This means that your chances of approval go way down if you have bad credit or if your business is on shaky ground. You might have better luck with a merchant cash advance if you have trouble qualifying for a P2P small business loan.

The bottom line

If you’re looking for an easy alternative to applying for a traditional small business loan, or even a personal loan for your business (yes, you can do that), P2P lenders might be worth considering, especially if you need faster access to cash than a traditional lender can offer. You’ll need to possess fairly good credit and a well-established, stable business to have a good chance of approval, but the rates will be lower than other quick-access, less risk-averse options like merchant cash advances. If you have a merchant account, chances are you can qualify for a merchant cash advance.

Tom DeSimone
Tom loves asking tough questions and getting straight answers, so he has a lot of fun calling payment processors for Merchant Maverick to cut through their smoke and mirrors and find the real deals. He has run a full-time editorial business from his home in New York’s Hudson Valley since 2010 and could not imagine a better job. When not busy writing and keeping credit card processors honest, Tom enjoys backpacking in the mountains.
Tom DeSimone
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