Peer-to-Peer Lending

Peer-to-Peer Lending
Peer-to-peer lending is a type of lending in which you get a loan from an individual—not a bank or financial institution. It is also known as P2P lending, person-to-person lending, or social lending. Peer-to-peer lending is most commonly done online.

What is Peer-to-Peer Lending?

Peer-to-peer lending is a way for you to get a loan without going through a bank or other financial institution. Instead, you connect with a private investor. The person functions as a lender and provides a loan. You are legally required to pay the money back along with interest.

How does Peer-to-Peer Lending work?

Peer-to-peer lending is most often conducted through online marketplaces. The process may differ depending on the marketplace, but it typically involves a few steps:

  1. You fill out an application.
  2. The lending site determines your creditworthiness through a credit check.
  3. The lending site assigns an interest rate based on your credit check.
  4. Investors offer loans that you can accept or deny.

If you accept a loan offer, you’ll be responsible for paying back the money you borrow. You’ll do so by making fixed monthly payments over the course of three to five years. You’ll have to pay interest to the lender, and the major lending marketplaces charge origination fees as well that range from one to five percent of your loan amount. They also charge late fees if you fail to make payments on time. They also charge a $15 fee if you opt to pay by check rather than through their site.1

Is Peer-to-Peer Lending safe?

Peer-to-peer lending is generally considered safe. However, it presents certain risks for both borrowers and lenders.

For borrowers, the dangers associated with peer-to-peer lending are largely no different than those inherent to a loan from a bank. You should read the fine print and watch for any hidden fees. You should make sure you’re not borrowing more than you can pay back. One risk presented by peer-to-peer lending is identity theft, as most lending marketplaces operate online. However, they take measures to ensure the security of your financial information, and the major lending sites likely pose no more of a threat than institutions that offer online banking.2

For lenders, the foremost risk that peer-to-peer lending presents is that the loans are not insured. They are not backed by the government and the lending marketplaces typically do not guarantee that lenders will receive their money back.3 That being said, the marketplaces make an effort to get delinquent borrowers to pay back their loans. They also allow lenders to distribute their money across loans to minimize risk. As a lender, you can select who to loan to and choose borrowers with better creditworthiness.4

How do I reduce risk as a lender with Peer-to-Peer Lending?

Most good investors invest in different loans with varying categories of risk. Higher risk loans come with higher interest, but that also mean there’s a greater likelihood that the borrower will default. Lenders who lean toward safe investments should offer loans to borrowers with better credit scores. The interest will be lower, but the borrower is more likely to pay your money back.

What are the Peer-to-Peer Lending options for people with bad credit?

If you have bad credit, you might be able to find a lower interest rate from a peer-to-peer lender than a bank. However, major lending marketplaces do have minimum credit score requirements. Also, if your credit is bad, you’ll have to pay a higher interest rate than someone with better credit. In addition, lenders are under no obligation to offer you a loan, and they may choose not to. In fact, one marketplace revealed that only 10 percent of their peer-to-peer applicants receive loans.5

When did Peer-to-Peer Lending start?

The concept of peer-to-peer lending has been around as long as money itself. With the advent of information technology, it made its way online and now investors around the world can locate borrowers who wish to avoid banks. Online peer-to-peer lending emerged in the early 2000s and has since then grown quickly.

What is direct Peer-to-Peer Lending?

Another form of peer-to-peer lending is called “direct P2P lending.” This kind of lending allows you to formally lend to or borrow from close friends or family members. There are many direct P2P companies that set up loan agreements and manage the funding process on your behalf. They can be found online.

How do I get approved for Peer-to-Peer Lending?

If you want to take out a peer-to-peer loan as a borrower, you must first be approved by the marketplace you hope to use. Different companies have different approval requirements, and some have minimum credit standards. If approved, you’ll be assigned a risk category between low, medium, and high. This determination will largely be based on your credit score and overall credit history. (The higher your credit score, the lower risk category you will be assigned.) Having a lower risk category is beneficial because it means you’ll pay a lower interest rate.

How do I receive money in Peer-to-Peer Lending?

Once you have your risk category and you’re up and running, investors can decide whether or not they want to lend you money. They do this by viewing your loan request (including the amount you’re requesting, your credit score, and other information) and deciding whether or not it would be a good investment.

If you’re approved, and the loan request is fully funded, you will receive the loan along with payment details. If a loan request is not funded up to a certain percentage of the amount asked, the loan will be denied and not processed any further.6 If approved, you may get up to five years to repay a loan ranging anywhere from $1,000 to $35,000.7

Bottom Line

As with any loan or financial arrangement, make sure to do your homework. Whether you’re choosing to borrow money or invest it, always review every aspect of the loan agreement. Check the principal, APR, term length, and other conditions and fees. Peer-to-peer lending can be beneficial for borrowers and investors alike, but it largely depends on your financial situation.

References:

1 Woodruff, Mandi. “Here's What You Need to Know Before Taking Out a Peer-to-Peer Loan.” Yahoo! Finance, 29 Aug. 2014, http://finance.yahoo.com/news/what-is-peer-to-peer-lending-173019140.html. Accessed on 23 March 2017.

2 Pritchard, Justin. “How Peer to Peer Loans Work.” The Balance, 4 Jan. 2017, https://www.thebalance.com/how-peer-to-peer-loans-work-315730. Accessed on 23 March 2017.

3 “Banking Without Banks.” The Economist, 28 Feb 2014, http://www.economist.com/news/finance-and-economics/21597932-offering-both-borrowers-and-lenders-better-deal-websites-put-two. Accessed on 23 March 2017.

4 “Is Peer-to-Peer Lending Safe?” Nasdaq, 4 June 2014, http://www.nasdaq.com/article/is-peertopeer-lending-safe-cm358911. Accessed on 23 March 2017. 

5 Roth, J.D. “Taking a Peek at Peer-to-Peer Lending.” Time, 15 Nov. 2012, http://business.time.com/2012/11/15/taking-a-peek-at-peer-to-peer-lending/. Accessed 23 March 2017.

6 Renton, Peter. “Understanding Peer to Peer Lending.” Lend Academy, Sept. 2015, http://www.lendacademy.com/Understanding-Peer-to-Peer-Lending.pdf. Accessed 23 March 2017.

7 Herrick, Kate. “Peer-to-Peer Lending Sites: Lending Club Vs. Prosper Vs. Upstart.” A Secure Life, 15 Jan. 2016, http://www.asecurelife.com/lending-club-vs-prosper-vs-upstart/. Accessed 23 March 2017.