Small Businesses Turn to Alternative Funding for Loans
People are always looking for ways to invest their money so that they can get a positive return. But when it comes to opportunities, most people tend to stay on the traditional path; putting their money into stocks, bonds, mutual funds, money markets or CD’s. But there are other ways, however, that a person can invest their money for a solid return.
In 2013, peer-to-peer lending is one of the hot investment strategies that Wall Street is starting to take notice of. The reason is that it’s expected that over $2 billion in loans will originate from peer-to-peer lending leader LendingTree this year and that number will likely double in 2014.
Others are getting into the game as well. By 2016, peer-to-peer lenders in the U.S. will be originating $20 billion in loans annually, claims Jason Jones, an organizer of the LendIt Conference and partner at New York-based Disruption Credit, an investment firm focused on online lending.
Renaud Laplanche, founder and CEO of LendingClub, stated in a speech to investors:
What we’ve done is radically transform the way consumer lending operates. The savings can be passed on to more borrowers in terms of lower interest rates and investors in terms of attractive returns.
The attractive returns come from algorithms that screen prospective borrowers for risk; rejecting 90 percent of them. While the rejection rate may seem high, it was done to help reduce the default rates, which hovered around 17 percent at one time, that scared investors away. LendingTree also has no physical branches to help keep operating costs low.
How Peer-to-Peer Lending Works
Like any loan, the interest rates the borrower gets are based primarily on their credit. The borrower fills out their application for the amount, usually up to $35,000, and purpose of the loan which they place online. Lenders then put money towards the loan; sometimes as little as $25 based on the interest rate set by the lending service and by the borrowers application. When a collective group of peers meets the borrowers amount, the loan is granted and is then paid back just like a traditional loan.
Lenders who are savvy with this investment strategy have learned to spread their loans out to many borrowers, capitalizing on the higher-risk, high-reward borrowers who are assigned the higher interest rates while balancing out their lending portfolio with safer bets on borrowers who are more likely to pay everything back.
And if the lenders and borrowers from one service can’t agree, there are many others to choose from.
Loans are often used for personal reasons, but more and more small businesses are starting to take advantage of peer-to-peer lending as a way to fund expansion or pay off debts. Since some businesses might need more than the typical $35,000 maximum, some peer-to-peer lending companies, like Dealstruck, decided to focus solely on the small business market offering loans between $100,000 to $1 million for two to five 3 year terms with interest rates between five and 15 percent.
Says Dealstruck co-founder Ethan Senturia:
We looked at the world and saw that what was a bankable loan five to seven years ago isn’t bankable, not because businesses were any worse, but [because of] changes in risk tolerance and regulation.
With no government backing, many financial insiders wonder how long peer-to-peer lending will remain a viable alternative for investors and borrowers alike. But as long as people continue to make money from it, the loans will most likely continue to be approved.