As big banks continue their retreat from small business and personal lending, new companies have sprung up to fill in the void. These new companies are happy to lend small amounts to businesses and even individuals. If you default, though, it may be your friends and family who are on the hook for paying back the loan.
On the Hook
That’s because these new online lending companies use borrowers’ social networks to help secure the loan and put pressure on the borrower to avoid defaulting. In some instances, the borrowers must effectively raise a quarter of the amount they’re asking for by persuading friends and family to put up that money. Getting the borrower’s social network involved does two things:
- reduces the risk for the lending company and the hedge funds that actually lend the money, and
- puts added pressure on the borrower not to default on payments because those friends and family are the first to take a financial hit on loan losses and they’re the last to get paid.
So, if a borrower defaults on a loan, it’s their social network (in addition to the primary lenders) they have to answer to.
Will you vouch for me?
Online lending companies that facilitate micro-loans for individuals will sometimes ask a borrower’s social network to vouch for them by acknowledging that they know the person and will even try to get the borrower’s friends and family to commit to repaying a portion of the loan if the borrower defaults. For example, they’ll ask people in the borrower’s social network to commit to paying back $100 of the loan if the borrower defaults.
Can I borrow …?
And yet another way to borrow money is by borrowing it straight from friends and family themselves via websites that work similar to Kickstarter. A person sets a certain goal to reach and the interest rate and then solicits their social networks to pledge money toward the loan. When the goal is reached, the money is transferred to the borrower and the interest payments to the loan are handled by the website that facilitated the loan.
While these new small-time lenders are carving out a decent niche in the wake of the big banks pulling away from small-time lending, investor sentiment at some of the venture capital and hedge funds that back these companies has turned a bit sour this year. Investors are displaying more scepticism about the relative value of the loans these companies provide as compared with other financial assets. There is also doubt about how online-originated loans will perform if the US economy slows down as drastically as it did in 2008.
Do you think these small loan companies will thrive or perish if the economy takes another downturn?[Photo courtesy of david pacey on Flickr]