April 30, 2015

Investing with online lenders requires careful consideration

Online lending is a marketplace on the rise - according to Barron's, venture capitalists recently contributed upwards of $150 million in equity to a variety of online lenders.

The attraction of online lenders relates to their flexibility. These financial institutions can make loans to a wider range of consumers, including in amounts too small for many traditional banks to execute efficiently. Many of these loans are also unsecured.

Overall, online lending has proven to be beneficial for a certain type of borrower, but investors should be aware of the risks involved.

Online lending can be attractive
Much of the attraction of online lending relates to the ability for individual borrowers to be exposed to a wider range of loan choices. From a small-business perspective, online lenders often have shorter approval processes, less paperwork and a more streamlined approach.

Of course, the longer process from a traditional financial institution is there for a reason - it ensures regulatory compliance and mitigates risk. However, this hasn't stopped small-business owners from turning to the world of online lending.

For example, business owner Yaniv Liron uses an online lender to quickly receive credit borrowed against outstanding invoices, according to The New York Times. By doing this completely over the computer, Liron can get cash deposited directly into his bank account.

"It's a handy tool," he told The New York Times. "I can't go to my employees and say, 'A client isn't paying me, so I can't pay you.' This helps even things out. I've tried all kinds of different methods of financing, and this was definitely the easiest."  It is notable that Liron did not state it was the lowest cost alternative.

Online lending presents varied risks
While online lending can be attractive for the right person, this doesn't mean this avenue is without its risks.

One of the key issues revolves around the size of the loan itself. Liron received a line of credit of only $2,500, according to The New York Times. Loans of these small amounts can be easily replicated by a credit card. However, credit cards are typically easier to obtain than a loan, not to mention often unsecured and paired with rates lower than the average loan generated on an internet lending platform.

When looking at online lending through a lens of high-rate, small-amount loans for thinly-capitalized businesses, it is easy to see where the risk begins to form. With this in mind, the best course of action is for investors to show caution when delving into the world of online lenders.