December 3, 2021

What Is Peer-to-Peer Lending and How Does It Work?

What Is Peer-to-Peer Lending and How Does It Work?
  • P2P lending lets you borrow directly from individual investors, bypassing banks or credit unions.
  • The process is quick and streamlined, and you’re likely to receive funds much more quickly than through a bank.
  • P2P is a good option for borrowers who may not qualify for a traditional loan. If your credit is good, you can land a surprisingly low rate.
  • This article is for business owners who want to know the pros and cons of P2P lending as well as how and where to apply.

If you’re looking to take out a loan, your first instinct is probably to apply for one with a bank or credit union. That’s certainly a valid option, but today, borrowers have lending options far beyond what a traditional bank or credit union can offer.

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For instance, peer-to-peer (P2P) lending allows investors to work directly with an individual or business looking to take out a loan. P2P loans often come with surprisingly low rates and a seamless application process.  

But what is P2P lending, and is it a good option for small business owners? This article will explain what P2P lending is so you can decide if it’s the right fit for your business. 

What is P2P lending?

P2P lending cuts out the bank or financial institution and allows individual investors to lend money to individuals and businesses. P2P lending has become a popular alternative form of lending thanks to the advantages it provides to both the borrower and the investor. 

P2P lending is often a good option for borrowers with bad credit who wouldn’t qualify for a loan through a bank. It allows them to access the financing they need without having to turn to predatory payday lenders. 

P2P lending is also a good option for business owners who are looking to take out a loan. The process is much faster than applying through a bank, and you could receive the funds within a week of approval. 

How does P2P lending work?

In P2P lending, an investor has some extra money that they are willing to lend. In return, the investor will earn interest on the loan payments. To get started, they’ll sign up for a P2P lending platform like Prosper or LendingClub.

These marketplaces match investors with borrowers who are looking to take out a loan. Once the borrower applies for a loan, they’ll fill out some basic information just like they would for a traditional loan. 

Most of the financial products offered are personal loans, though the lender can set their own criteria. For instance, some lenders will provide loans specifically geared toward debt consolidation. [Related: Tools to Help Manage Business Finances]

After the borrower has filled out the application, the lender will check their credit score and decide whether to approve them for the loan. Once the borrower is approved, the lender will fund the loan.

Benefits of P2P lending for businesses

For businesses, P2P lending allows them to seek out the financing they need without applying through a bank. Let’s look at some of the biggest pros and cons of P2P lending. 

Pros

  • Streamlined application process: The most significant advantage of P2P lending is the easy application process. Businesses will have to deal with far less paperwork, and you’ll know whether your application is approved or denied almost immediately. 
  • Low rates: P2P lending comes with surprisingly low rates because individual investors don’t have to pay the same overhead as banks. Of course, you should always do your homework to ensure you’re getting the best deal possible. 
  • Options for imperfect credit: Anytime you’re applying for a loan, the higher your credit score is, the better. But with P2P lending, imperfect credit won’t necessarily disqualify you from loan approval.
  • Fast funding: Once you’re approved for a P2P loan, you should receive the funds within a week. However, some marketplaces promise financing in as little as three days.

Cons

  • Fees: Although you may receive a low interest rate, P2P loans often have additional fees. For instance, some lenders will charge an origination fee between 1% and 8% of the total loan amount. Make sure you read the fine print before agreeing to the loan.
  • High rates: One of the advantages of P2P lending sites is that excellent credit isn’t necessary to qualify. But if you have poor credit, you may get stuck with high rates and unfavorable repayment terms.

P2P sites for businesses

P2P marketplaces have grown tremendously in recent years, so it can be hard to know where to look first. If you’re interested in taking out a P2P loan, here are the four best options for small businesses. 

1. Funding Circle

Funding Circle offers small business loans between $25,000 and $500,000 with terms ranging from three months to 10 years. You’ll receive a loan decision within 24 hours, and once you’re approved, you’ll receive the funds within three days.  

You will need excellent credit to qualify for a loan through Funding Circle. But initially, the company will do a soft pull on your credit, so there is really no downside to applying. 

2. StreetShares

StreetShares offers P2P loans specifically designed for small businesses that have strong cash flow. The loans range from $2,000 to $100,000 with term lengths from three months to three years. 

Once your application is approved, you’ll receive the funds almost immediately. And there are no prepayment penalties, but you will have to make weekly payments.  

3. LendingClub

LendingClub offers business loans from $5,000 to $500,000 with repayment terms between one and five years. The company connects businesses to a network of lenders through its partnership with Accion Opportunity Fund. 

When you’re ready to apply, you’ll be assigned to a dedicated client advisor who will walk you through the application process. LendingClub is a good option for businesses that have a hard time getting approved for a loan from a traditional lender. 

4. Upstart

Upstart offers loans between $1,000 and $50,000 to individuals looking to start or expand a business. You’ll make monthly loan repayments over a repayment term of three to five years. Upstart doesn’t charge a prepayment penalty, but it does charge a one-time origination fee.

Upstart is an excellent option for borrowers looking to get a new business idea off the ground. The company prides itself on looking at a borrower’s potential and has tons of positive reviews. [Related: Small Business Guide to Getting a Loan]

Other types of loans available with P2P lending

Personal loans are not the only option in P2P lending. Here are some of the other loan options available to businesses and consumers:

  • Small business loans
  • Debt consolidation
  • Mortgages
  • Student loans
  • Auto loans
  • Auto refinancing
  • Medical expenses

P2P FAQs

What can I use a P2P loan for?

In general, you can use a P2P loan for any purpose you choose. You can use the money to fund a small business expense, consolidate debt or pay for an upcoming trip. 

The only exception is if your lender puts certain limits on what you can use the funds for. For instance, some lenders offer P2P loans specifically aimed at debt consolidation. As another example, if you take out a business loan, you may not be able to use that money toward personal expenses.  

What are the risks of P2P lending?

The investor takes on most of the risks involved in P2P lending. Every time an investor lends money, there is a chance that they won’t be able to recoup the funds, or, if the P2P marketplace suddenly closes, they may be unable to recover their investments.

But there are risks for the borrower as well. For businesses with bad credit, you may not qualify for the best rates and terms on your loan. Though you’ll receive access to the funding you need, you could end up paying a lot of money in interest.

How do I apply for a P2P loan?

If you’re interested in taking out a P2P loan, your first step is to find a lending marketplace. Look for sites that have a reputation for being trustworthy and a history of good customer reviews. It’s also a good idea to see how that business is rated by the Better Business Bureau.

Once you’ve chosen a marketplace, you’ll begin the application process. You’ll start by stating how much money you’re looking to borrow and the purpose of the loan. From there, you’ll enter your personal information and agree to a credit check.

After you’ve been approved for a loan, you can review your interest rate, repayment terms and any additional terms for the loan. If you agree to the terms, you’ll take the loan to the funding stage. 

During the funding stage, the potential investors will review your application and decide whether or not to fund the loan. Once you’ve received the funds, you’ll move into the repayment stage. At this point, you’ll begin making weekly or monthly payments to repay the loan. 

The bottom line on P2P lending

If you’re looking to take out a small business loan and hoping to avoid the headache of applying with a traditional lender, P2P lending is a good alternative. P2P lending cuts out the financial middleman and allows you to borrow money directly from individual investors.

If you have an excellent credit history, you could qualify for a low interest rate. However, borrowers with poor credit are not disqualified from applying. 

Once you’re approved for a loan, make sure to do your due diligence. Compare offers from several lenders, and make sure the loan is worth what you’ll be paying.