If you are an entrepreneur who is seriously considering peer-to-peer lenders, the next question is which one should you pick. While there are many peer-to-peer lenders available, this article will compare three popular lenders as an example of how you might compare your choices. Before I even begin on the topic, let me qualify the information here by stating that lending rates and conditions change frequently, so to really know your situation, you must check with the lender for their current terms.
Peer-to-peer Business Models
While a bank makes money on the difference in the rate it charges for loans and the rate it pays for deposits, peer-to-peer sites make money for servicing loans. Peer-to-peer lenders avoid overhead costs such as branch facilities, staffing, and costs associated with meeting regulations.
The auction model of peer-to-peer lending uses the Internet to help individual lenders find individual borrowers. Lenders bid on the interest rate and the amount they are willing to finance and compete with other lenders to provide the best rate for the borrower. Prosper uses the auction model.
The community lending model of peer-to-peer lending focuses on the established relationship between the lenders and the borrowers. Unlike the auction model, the family and friends model does not connect borrowers with lenders. It simply formalizes and services loans that might have been made anyway. Part of the motivation for community lending is that the relationships between lenders and borrowers might put peer pressure on borrowers to repay the loan. Virgin Money US uses the family and friends model.
Advantages to Borrowers
There are several advantages to borrowers. First, unsecured consumer loans through peer-to-peer lenders have an interest rate of about 12% as compared to higher rates, maybe 20% to 30%, on credit cards. Second, Peer-to-Peer lenders are typically faster and have less red tape than traditional lenders. Third, Peer-to-Peer lenders may not need as much information. Limited borrowing history makes it difficult to get loans from traditional banks. Banks might need up to 5 years of financial data to evaluate a business loan request. Fourth, if the borrower falls behind on payments, Peer-to-Peer lenders are more likely to restructure a loan in arrears than a bank. Fifth, the borrower may trust individual lenders more than institutions. Catherine Graeber from Forrester Research, Inc. reports that people see an inherent conflict of interest with banks. Borrowers believe bankers are more likely to take actions based on the best interest of the bank rather than the best interest of the customer.
Disadvantages to Borrowers
There are several potential disadvantages of borrowing through Peer-to-Peer lenders. First, in some states, loans of less than $50,000 can have a cap on the maximum interest rate making it difficult to find individual willing to loan in peer-to-peer networks. Second, all loans have fixed payments that would not necessarily be appropriate for business purposes for small businesses with seasonal sales. Third, these personal loans might hurt personal credit scores and make it more difficult to get additional financing.
Table 1 Peer-to-peer Comparison for Unsecured Loans
| Company | Lending Club | Prosper | Zopa |
| Minimum Loan Amount | $1,000 | $1,000 | None |
| Maximum Loan Amount | $25,000 | $75,000 | $50,000 |
| Borrower
Interest Rates |
6.39 to 24.15% | 7.5 to 35.0% | 9.7 and up |
| Maximum Term | 5 years | 3 years | 7 years |
| Origination Fee | 2.25 to 5.00% | 0.50 to 4.50% | None |
| Minimum Credit Score | FICO 660 | Experian 600 | FICO 640 |
| Maximum Debt-to-income | 25% | none | none |
| Service Fee | 1.00% of monthly payment | 1.00% of annual loan amount | .50% of annual loan amount |
Source: fivecentnickel.com, peer-lend.com, bankrate.com, lendingclub.com, prosper.com, virginmoneyus.com, and zopa.com accessed on 9/01/10.
Peer-to-peer lending provides an alternative to traditional funding sources. Just remember, as with any other type of loan, you still have to repay it, and fees for late payments or defaulting can be very steep. In addition, the loan limits might pose a problem for an entrepreneur who wants to launch a major innovation. However peer-to-peer loans might provide reasonable on a project by project basis particularly when other sources are limited.
About the Author:
Calvin Bacon is the Director of Creative Services at Wisepreneur.com. His areas of interest include idea generation and innovation management.
