AS CREDIT TIGHTENS, a growing number of entrepreneurs are turning to peer-to-peer lending sites to get the cash they need. But such loans can hurt personal credit scores — and potentially get business owners in over their heads, warn credit and lending experts.
Peer-to-peer lenders such as Prosper , Lending Club and Zopa provide online forums through which people looking for a cash fix can seek out unsecured loans (of typically less than $25,000) from willing lenders. On Prosper, for example, a newbie entrepreneur can list the amount they want to borrow and the interest rate he or she is willing to pay; lenders then bid on the loan eBay-style. Lending Club and Zopa similarly match individual borrowers and lenders.
For business owners, the attraction to peer-to-peer lending is simple: They’re often able to get loans more easily and more cheaply than they would at a traditional lender. Start-ups have long found that their limited track record makes it difficult to secure lines of credit or conventional bank loans. But now, as a result of the credit crisis and softening economy, even established businesses are finding it harder (and costlier) to obtain money from credit-card companies or banks.
Peer-to-peer lending sites, which typically promise to deliver loan money in a matter of days, are “definitely addressing a gap in the market,” says Gerri Detweiler, a credit specialist in Sarasota, Fla., and co-founder of BusinessCreditSuccess.com, an advice site for business owners. For the business owner who depleted his personal savings and doesn’t have any friends or family members to turn to for help, or for the entrepreneur who has been denied funding at every turn, peer-to-peer loans can seem something like a miracle.
But business owners looking for a peer-to-peer cash infusion should proceed with caution. For starters, “while the borrower may think of [a peer-to-peer loan] as a business loan, it’s really just a personal loan that you’re going to use for business,” Detweiler warns. “By adding a new loan to your debt, your credit score may go down.”
On Zopa, for instance, a business owner may seek a so-called “small business loan” to finance a new or existing enterprise. But the loan, which is based solely on the owner’s credit record, will be reported on their credit report as a personal loan instead. Zopa CEO Doug Dolton notes any borrower who seeks a loan through the site is provided with information stating that the loan is a personal loan. To get a free quote, business owners must provide their Social Security number and authorize Zopa to obtain their credit reports. “It’s immediately obvious that what we’re doing is about your personal credit score,” he says.
Yet, some business owners might not be aware that peer-to-peer loans, just like personal credit-card debt, are considered “consumer” debt, even when used for business purposes. “The dilemma is that credit-scoring models were not built to take into account ‘atypical’ examples,’ such as small-business expenditures,” says John Ulzheimer, president of consumer education in Atlanta for Credit.com. An entrepreneur with limited financing options might turn to a peer-to-peer lender (or a personal credit card) to buy, say, pricey office equipment or machinery that can help him grow a profitable business. But the credit-scoring model would simply view that person as “a consumer who has an insane amount of debt,” he says. As a result, the business owner’s credit score could plummet, making it difficult to attain future loans from traditional lenders, and even credit from vendors or suppliers.