In an article yesterday (“Peer-to-Peer Loans Grow”), the Wall Street Journal discussed increasing use of peer-to-peer lending sites such as Prosper and Lending Club by small-business owners.
The reason such use is increasing: During and since the financial crisis, small businesses have had a difficult time obtaining bank loans, and the loans that they can obtain often have unfavorable terms.
How peer-to-peer lending works: The borrower pays the site a fee. The site analyzes the borrower’s creditworthiness, sets an interest rate accordingly, and posts the loan. Investors anonymously invest small amounts – less than $1,000 – in loans that interest them. As each loan payment is made, each investor receives his or her portion. Because the site has low overhead, borrowers pay a lower interest rate that they would to a bank; in turn, investors receive a higher return than they would from many other investments.
The sites are regulated by the Securities and Exchange Commission. As a result, they issue prospectuses that highlight the risks of using the sites. For example, the Prosper Prospectus includes more than 20 pages of risks related to borrower default, Prosper’s ability to service the notes, and the like.
Perhaps most important, in the event of a default, the lenders cannot go after the borrower directly. As a result, lenders should be prepared to lose the entire amount of their investments. However, with default rates of less than three percent, peer-to-peer lending can make sense for investors who spread their money in small chunks among many loans – and it makes a huge amount of sense for borrowers who cannot obtain money elsewhere.
Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
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