P2P vs. Line of Credit: Avoid the Wrong Funding

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When you’re a cash-strapped business owner, it’s hard to know which funding option is right for you. Should you go with a business line of credit or a peer-to-peer (P2P) loan? Not long ago, growing businesses in need of short-term cash to shore up cash flow or buy equipment would turn to their bank in the hopes they could qualify for a short-term loan or a business line of credit. Since the financial crisis of 2008, growing businesses are finding that banks are not as accommodating as they once were, especially if the business is relatively new or has less than perfect credit. Although a business line of credit may be the ideal solution for businesses with temporary cash needs, they do have their own obstacles when trying to obtain them. Luckily, small business owners now have more choices about where to get their funding.

Click here to read more about P2P loans

As bank lending dried up during the crisis, a new source of lending came to life in the form of peer-to-peer lending, which has put the power of lending and borrowing directly in the hands of people. Although it may not be the ideal source of lending for businesses, P2P lending has become the lifeline many businesses have needed to survive and even flourish.

What Exactly Is P2P Lending?

At its core, P2P lending is a digital online marketplace where borrowers meet individual investors seeking a better return on their money than what is available with traditional investments. P2P lending has been more succinctly described as “lending-based crowdfunding” because a borrower who has a need for, say, $30,000 goes on a website and makes a pitch with the objective of attracting multiple investors to form a syndicate to finance the loan. The P2P lender assesses the creditworthiness of the borrower and assigns a rating as well as interest rate, and investors can view the profile to determine if they want to participate. Investors can commit as little as $25 to a loan, and most investors invest in a diversified portfolio of loans in order to spread their risk. The loan terms are usually short, between three to five years, and the rates can range from six to 35 percent depending on the creditworthiness of the borrower.

Advantages and Disadvantages of a P2P Loan for Your Business

A P2P loan really only has one advantage for a business owner—it is more easily obtained than a loan or line of credit from a bank. But, for business owners in dire need of cash, what other advantage do they need? Otherwise, P2P loans can be expensive. Although P2P loans are fixed term loans, they can be paid off early without penalty so businesses don’t have to carry the interest costs any longer than is necessary. The key for a business going through a P2P lender is to borrow no more than you absolutely need, so thorough cash flow planning is of the essence.

Advantages and Disadvantages of Business Line of Credit

A business line of credit is easy to understand if you know how a revolving credit card or a home equity line of credit works. Based on the credit standing of the business and the owner, as well as the financial health of the business, the lender approves a total amount of money that may be borrowed and repaid at the discretion of the borrower. There are several advantages of a business line of credit, the biggest of which is the low cost. The rates on a business line of credit are much lower than credit card rates, and they can be as low or lower than short-term loan rates. More importantly, the borrower can control interest costs based on how much is actually borrowed. Most lines of credit require interest-only payments; however, the principal can be paid back in full at any time.

The only real disadvantage of a business line of credit is the difficulty in obtaining them. For a less established small business with less than great credit and shaky business financials, it can be near impossible. However, any small business can work to improve its financials and credit history to gain a better chance for approval, but it will take time. Many small business owners are choosing alternate sources of a business line of credit provided by platform lenders instead of banks.

More established small businesses with steady revenue and a sound credit history have more options for obtaining short-term financing; and, for many, a business line of credit is an ideal solution. Over the long term, building a solid relationship with platform lenders or other financial institutions is always in the best interest of a growing business.