Peer-to-peer lending is an online form of lending between two people. To find a lender, the borrower doesn’t need to visit a bank. They can instead use an online marketplace to find one quickly and with less paperwork.
Peer-to-peer lending started as an industry for personal, unsecured loans. There was no collateral. This now includes secured loans as well as business loans. Let’s take an in-depth look at the information you need to know.
Peer-to-peer lending defined
Peer-to-peer lending (P2P) is an online form of lending. An algorithm matches the borrower with the lender.
P2P lending can be a more efficient way of borrowing money than traditional loans through banks or credit unions. This convenience often comes at a higher cost to the borrower.
How does peer-to-peer lending work?
Let’s take a look at how lending works for both the lender and the borrower.
A borrower can get P2P financing
P2P lending gives borrowers more freedom than traditional loans. Every year, a bank or credit union must adhere to thousands of regulations and undergo multiple audits. You, your boss, or even a neighbor could be your P2P lender. These lenders may be more inclined to lend if they can use sophisticated fintech algorithms rather than traditional metrics such as credit scores and debt to income ratios.
Minimum credit requirements are required for P2P platforms. Upstart (NASDAQ: UPST) requires credit scores of at least 560 and no bankruptcy within the past 12 months. You must have no delinquent accounts, and you cannot answer more than six questions about your credit history in the last six months. After this screening, potential borrowers that aren’t worth the investment in return will be removed. After the initial screening, many marketplaces allow borrowers and lenders to connect.
The P2P marketplaces are more open about the reasons behind rejections. Banks and other financial institutions might have to keep declines under control in order to avoid legal problems.
You must submit an application on the marketplace’s site to determine which type of loan you qualify for and the interest rate. The loan can be accepted or declined. Once you accept the loan, you will make an ACH payment (Automated Clearing House), sign the loan documents, and pledge collateral to ensure it is secured.
At the time of loan creation, the fee is due. The fees for P2P loans can reach 8% as opposed to the 1% that traditional banks charge. Personal Loans for People with Good Credit. Markets make money by charging high fees. Calculate the cost of higher fees to make up the difference.
Lenders have the option to use P2P lending
Individual investors might find P2P lending a good investment. Due to the saturated market and high rates, it is difficult to find a bond investment with a higher return than 5%.
High risk is associated with P2P borrowers. They are often unable to get loans from traditional banks and so they turn to P2P lending. We’ll discuss the risks further below.
Marketplaces are where P2P lenders can deposit money to invest and find funding. They then lend. Usually, the marketplace will require that you fill out an application detailing your willingness to take on risk and the types of loans you would like to receive.
Log in to see all loans available and make a decision about whether or not you want to invest. While some marketplaces might assign loans a risk rating depending on their lending criteria, all lenders should have information about the borrower. You can also invest through certain marketplaces in similar loans.
Is peer-to-peer (P2P) lending safe?
Credit risk is the main concern for P2P lenders. P2P lending is a popular alternative to traditional bank loans for many P2P borrowers. Traditional banks may not always be the most qualified to assess credit quality.
Over the past 50 years, the standards for bank credit have remained fairly stable. Before making a subjective determination, the underwriter will review income and debt, look at collateral, and consider credit scores and credit history.
Financial technology companies (fintech) are now looking at other credit scores. They use unconventional criteria to grade loans and are more flexible in determining interest rates that meet credit risk.
P2P loan defaults can still occur, despite this. Nearly all loan products come with credit risk. Diversification is the best method to reduce credit risk in this type of fintech. It is better to invest $50,000 in P2P loans and distribute it among 10 borrowers with $5,000 each than to spend it all on a single borrower. You can still get your money even if one borrower defaults.
What are the pros and cons of P2P lending?
Let’s take a look at the perspectives of both the borrower as well as the lender to understand the pros and cons.
- Interest rates: P2P lenders don’t have the same infrastructure or operating expenses as traditional banks so they can charge lower interest rates to pay overhead. P2P marketplaces might set interest rates according to risk. Borrowers with baggage will pay higher rates.
- Flexibility: Traditional banks have to keep everything in one place. An auto loan, home equity credit, or credit card account can all be obtained. In terms of loan proceeds and loan amounts, P2P lenders are more flexible than traditional lenders. They are also quicker to approve loans and can have quick access to cash.
- Marketplaces make their money by charging fees. Many marketplaces charge fees on a sliding scale. However, these fees are usually more costly than what you would pay at the bank. This fee is often paid by borrowers for convenience, lower interest rates, or approval.
- Overextending: Although the traditional income/bank debt standards may seem old-fashioned, they still have a purpose. If your debt-to-income ratio is high, it’s not worth applying for a P2P loan.
- Higher returns: Individuals have the option to build portfolios of personal loans that offer higher interest rates via P2P lending.
- Impact: You are buying stock or bonds with the intention of making an impact on other people. Your donation could allow a couple to afford infertility treatment or help someone buy their first house or continue with a costly medical procedure.
- Credit risk: P2P borrowers may not be eligible for traditional loans. They might also have income problems or debt problems which make it difficult to repay loans.
- If you choose a smaller market or have high standards, there may not be many investment options.
What are the best uses for a P2P loan, and what should they be used for?
You can borrow money from P2P for many purposes. Some marketplaces require you to disclose your use of funds when you apply. To ensure that the loan is properly used, they also keep track of the usage. These are some of the most common uses for the loan:
- Consolidate your debt
- Real estate
- Medical expenses
- Business loans
- Miscellaneous major expenses
Where can I apply for a P2P loan?
Personal loans are the best way to locate a P2P loan marketplace. Each website offers different types of loans, so it is important that you choose the best one.
You can choose from many of them, then visit their websites to find out which one is the easiest and has the best fee structure.