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What Is Peer To Peer Lending?

Key Takeaways:

  • P2p lending occurs when people lend or borrow money from each other without going through a bank. In its pure form, it can be something as simple as lending money to a friend in need.
  • A peer-to-peer lending website allows individuals to borrow money from other individuals without going through a bank. It also enables small businesses to borrow money from investors.
  • By cutting out the middle man (financial institutions), a peer-to-peer lending site links borrowers directly to investors. The site usually sets the rates, defines the terms, and facilitates transactions.
  • P2p lending aims to incentivize savers with higher interests (when they lend out money) and borrowers with unsecured personal loans that offer comparatively better rates.

    In its basic form, p2p lending can be something as simple as providing a loan to a friend in need. The peers in this case are you – the lender and your friend.

    The borrowers and lending activities in this case don’t involve a bank or financial institution. Hence peer-to-peer lending simply means lending amongst peers.

    We’ll look at what peer-to-peer lending is and how it works.

    What is Peer-to-Peer (P2P) Lending?

    Peer-to-peer lending is a way of lending or borrowing money that does not involve a bank or financial institution.

    In its organized form, it occurs online on a website that connects investors looking to lend out money to borrowers looking for loans.

    When you lend out money to a friend in need, you have engaged in peer-to-peer lending. The peers in this case are you – the lender and your friend – the borrower. This activity occurs in a more organized, rewarding, and complex form online. 

    P2p lending, also known as social lending, marketplace lending, or crowd lending also enables small businesses to obtain unsecured loans from investors without going through a bank.

    Peer-to-peer lending is based on a crowd-funding model that aims to incentivize savers with higher interests (when they lend out money) and borrowers with unsecured personal loans that offer comparatively better rates.

    P2p lending – in its organized form – has been around since 2005. Some of the biggest p2p lending platforms include Prosper, Lending Club, and Upstart.

    How Peer-to-Peer Lending Works

    Peer-to-peer lending platforms are built around a single premise: to match lenders directly with borrowers.

    A p2p lending website serves as a bridge linking lenders and borrowers. 

    Here’s how it works: 

    • A potential borrower in need of a loan signs up on the p2p lending website and fills out an application. 
    • The platform processes the borrower’s request and determines the applicant’s creditworthiness after which the applicant is assigned an interest rate corresponding with his credit rating. 
    • Lenders see these loan requests and can choose who they give money to. The platform also provides investors with all sorts of information about the borrowers so they can make informed decisions. Some lenders might only lend to the safest borrowers and settle for a lower return while others might reach for a higher yield but accept a higher degree of risk. 
    • If the borrower’s application is approved, he will be presented with available options from investors on the platform based on his credit rating and assigned interest rates.   
    • The borrower then assesses the options presented to him and has to decide which one to choose.
    • If the borrower eventually accepts a loan offer, he will be required to pay periodic interest payments and repay the principal amount at maturity.
    • The lending platform charges a commission – to both lenders and borrowers – for providing services.

    What Can I Use P2P Lending For?

    P2p lending can be a good way for investors to get higher interest by lending money out instead of saving it. For borrowers, it can be a good way to get an unsecured personal loan at comparatively better rates. 

    P2p lending can be an attractive option for those looking to boost their investment portfolio and are willing to take a small amount of risk to do so.

    While p2p lending provides an avenue for investors to make money lending out money, there are risks involved. 

    Is P2P Lending Safe? 

    P2p lending is inherently risky. Unlike saving money with a bank, investing in a p2p lending platform involves the full assumption of risk. 

    Here are some of the risks involved: 

    • No Insurance coverage: Lenders aren’t covered by deposit guarantee schemes like the FDIC. The lack of insurance coverage means that lenders lose money if borrowers are unable to keep making payments and default. 
    • Credit risk: Because many borrowers who use P2P lending platforms have low credit ratings usually stemming from poor credit history, they pose a high credit risk which increases the probability of defaulting on a loan. 
    • Platform risk: There’s near limited to no protection if a peer-to-peer lending website goes bankrupt. 

    Where to Get a P2P Loan

    You can obtain a p2p loan from a variety of p2p lending websites. The following are websites that offer p2p loans: 

    Upstart: Best for new borrowers

    Upstart is a p2p lending platform dedicated to borrowers with limited credit history. The site takes a rather unconventional approach to evaluating borrowers.

    It takes into account over 1,500 variables in its evaluation (underwriting) process. The platform has an origination fee that ranges from 0% to 10%.

    Rates range from 5.6% to 35.99% and loan offers range from $1,000 to $50,000

    Lending Club: Best for fair credit

    Lending Club is one of the biggest names in the p2p lending space. The platform launched in 2007 and has facilitated transactions worth $50 billion.

    The p2p lending website offers different types of loans such as car financing, personal loans, and business loans.

    Loan offers start from $1,000 and investors can also start with $1000. 

    Prosper: Best for good to excellent credit

    Prosper launched in 2005 as the first p2p lending platform in the U.S. The platform offers personal loans that range from $2,000 to $40,000 to qualified borrowers with origination fees ranging from 2.41% to 5%.

    To qualify, you will need a credit score above 600. The platform boasts that more than 80% of its investors met or surpass their expected ROI. 

    Purpose CategoryBest Options
    Personal loanPeople with no credit historyUpstart
    Personal loan, business loan, debt consolidationPeople with fair creditLending Club
    Quick fundingPeople with good to excellent creditProsper
    Where to get a P2P loan 

    How to Invest in Peer-to-Peer Lending

    Explore the best options

    A good place to start if you want to invest in peer-to-peer lending platforms is to explore the best options available by researching the market.

    Some of the things to consider when looking for a p2p lending platform to invest in include default rates, loan terms, average return on investment, fees, and interest rates.

    You can also check online for reviews about the website to see what others are saying about it.

    Choose a platform and create an account

    Once you have found a platform, open an account as an investor (or lender).

    You may be required to provide information like how much you want to invest, the length of the loan, and your preferred interest rate.

    Start with small loans

    Once you have signed up on the platform and created an account, start with small loans rather than large ones.

    By focusing on multiple smaller loans, you spread out your money and alleviate risk if a borrower defaults on a loan.

    Reinvest your gains

    Grow your portfolio by reinvesting your gains back into the platform.

    The Bottom Line

    Although p2p lending is a relatively new space, the concept behind it has been around for centuries. A peer-to-peer lending platform is a bridge that connects lenders with borrowers.

    P2p platforms are based on a model that cuts out the middle man and allows lenders to gain higher interest rates than they would be saving money in a bank.

    On the other side of the divide, it enables borrowers to gain comparatively better rates.

    As a prospective lender, It is important to do some research before investing in p2p lending. This will help you understand what the market is like and help you find the best options that suit your preferences.

    As a prospective borrower, it is important to explore the different platforms available to find the one that best meets your needs.

    FAQs

    How do I get into peer-to-peer lending?

    To get into peer-to-peer lending as an investor, you have to know what the market is really like. A good place to start is to explore the best options available by researching the market. Then choose a platform and create an account. Ensure to start with small loans and reinvest your gains to grow your portfolio. 

    Can you make money with peer-to-peer?

    Peer-to-peer lending works on a crowdfunding model which means that users on the platform provide funding to other users seeking loans. Since there’s a fee for borrowing money (interest rate), users that provide funding can grow their money over time barring serious borrower defaults. 

    Can you lose money with peer-to-peer lending?

    The profit prospect of peer-to-peer lending lies in the low default probability. If a lender provides a loan to a borrower who is unable to pay back, he will lose his money. Since lenders on p2p platforms aren’t covered by deposit guarantee schemes like the FDIC, they can lose money if borrowers are unable to keep making payments and default. 

    Do you need good credit for peer-to-peer lending?

    It depends on the platform. Some platforms require that you have a credit score above 600 to qualify while others offer loans to people with a limited credit history. 

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    Sources

    Abraham is the Assistant Country Manager for Financer US. He is a research analyst with a strong background in economics and an avid interest in personal finance and investing. He has written hundreds of articles on personal finance, investing, cryptocurrencies, technology, and iGaming.

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    Last Updated: November 18, 2022

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