Peer Lending Grows as Small Biz Option

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NEW YORK (MainStreet) -- When John Good, owner of the Bubbles Galore Car Wash in Davison, Mich., went to his local bank last year to get a $16,000 loan to expand into the self-serve dog washing business, he was denied.

First Place Bank, a subsidiary of First Place Financial in Warren, Ohio, already held the note for Good's original $500,000 Small Business Administration start-up loan, but the bank required massive documentation and fees -- requirements Good felt were too costly, time consuming and frankly, annoying, given the amount. "The amount of money we were requesting didn't merit the amount of work and back-end costs," Good says.

That's when Good heard about peer-to-peer lending.

Peer lending is not necessarily new, but there are a growing number of business borrowers turning to them -- in part because, as interest rates remain near record lows, investors are looking for options that will make decent returns.

In the U.S., the two largest peer lending sites are Prosper.com, which has funded $214 million in loans since 2006, according to its website, and 3-year-old Lending Club.

Lending Club's chief executive, Renaud Laplanche, sees an increasing number of investors looking to invest in more small businesses, which frees up more cash for loans. Last year, the overall average initial investment through Lending Club rose to $8,700 by December from $1,800 in March, the company says. Funded loans recently passed the $200 million mark, doubling its volume versus nine months earlier.

Lending Club is targeting an average initial investment of $15,000 by year-end.

"The No. 1 reason why borrowers choose Lending Club as opposed to a bank is lower interest rates. We are a peer-to-peer lending network and therefore create a more efficient way of getting funding to borrowers, whether small businesses or individuals," Laplanche says.

How It Works
Lending Club offers a maximum of $25,000 in either three-year or five-year maturities. Borrowers are allowed up to two loans in active repayment.

Money to fund the loans comes directly from qualified investors (withat least $70,000 in annual income and $70,000 in net worth), not lending institutions.

Applicants must be at least 18 years old, with a valid bank account, a FICO score of at least 660 and debt-to-income ratio at most of 25% (excluding mortgage), among other requirements, according to the company.

Applicants fill out an online application and are told immediately whether they passed the initial screening. If they pass, they are given loan options and their confidential request is posted to the website for two weeks or until the loan is fully funded.

"The process is simpler because we do not underwrite the business itself, we just underwrite the business owner," Laplanche says. "The business owner can get a loan based on his own financial situation and his own credit history. It's fully automated and it's no different from getting a credit card or getting a personal loan from a bank."

Origination fees are between 2% and 5% of the loan amount.

Annual percentage rates, which includes the loan interest rate and fees, average about 11% for three-year loans and 14% on five-year loans. That compares with an average 15% to 24% at banks, Laplanche notes.

Websites such as Lending Club also become a sort of clearinghouse to borrowers by having someone in the middle saying "this investor is legit."

But borrowers need to understand that risks are involved, since peer lending investors are not subject to the same rigorous guidelines as banks, warns Marilyn Landis, founder of small-business consultancy Better Business Concepts and a board trustee to the National Small Business Administration.

Borrowers need to be extra careful when agreeing to loan terms -- perhaps even bringing in an accountant or counsel to review the terms. Landis also suggests that applicants find out whether they can repay the loan early and, if so, if a cost is involved.

On the other hand, "because they are not regulated, investors could be friendly to your industry or friendly to you," Landis says. "You may have a more patient, flexible, more workable mentor that you would not otherwise have."

Good, the owner of the car wash/self-service doggie wash, got his $16,000 loan last year through Lending Club and says he would absolutely use peer lending again.

It took less than seven days from the time he submitted his application to Lending Club to get the funding, Good says. Several potential investors asked questions, with the most wary asking why Good's company didn't have cash on hand to fund the expansion. (Because that cash is also an emergency fund, Good says, and "Nobody wants to drain that emergency fund.")

The diversification has paid off, Good says. He's looking to fully repay the loan at month 20, nearly a year and a half earlier than expected.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

 

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