A form of direct money lending to individuals or businesses without an official financial intermediary
What is Peer-to-Peer (P2P) Lending?
Peer-to-peer lending is a form of direct lending of money to individuals or businesses without an official financial institution participating as an intermediary in the deal. P2P lending is generally done through online platforms that match lenders with the potential borrowers.
P2P lending offers both secured and unsecured loans. However, most of the loans in P2P lending are unsecured personal loans. Secured loans are rare for the industry and are usually backed by luxury goods.Due to some unique characteristics, peer-to-peer lending is considered as an alternative source of financing.
How Does Peer-to-Peer Lending Work?
Peer-to-peer lending is a fairly straightforward process. All the transactions are carried out through a specialized online platform. The steps below describe the general P2P lending process:
- A potential borrower interested in obtaining a loan completes an online application on the peer-to-peer lending platform.
- The platform assesses the application and determines the risk and credit rating of the applicant. Then, the applicant is assigned the appropriate interest rate.
- When the application is approved, the applicant receives the available options from the investors based on his credit rating and assigned interest rates.
- The applicant can evaluate the suggested options and choose one of them.
- The applicant is responsible for paying periodic (usually monthly) interest payments and repaying the principal amount at maturity.
The company that maintains the online platform charges a fee for both borrowers and investors for the provided services.
Advantages and Disadvantages of Peer-to-Peer Lending
Peer-to-peer lending provides some significant advantages to both borrowers and lenders:
- Higher returns to the investors: P2P lending generally provides higher returns to the investors relative to other types of investments.
- More accessible source of funding: For some borrowers, peer-to-peer lending is a more accessible source of funding than conventional loans from financial institutions. This may be caused by the low credit rating of the borrower or atypical purpose of the loan.
- Lower interest rates: P2P loans usually come with lower interest rates because of the greater competition between lenders and lower origination fees.
Nevertheless, peer-to-peer lending comes with a few disadvantages:
- Credit risk: Peer-to-peer loans are exposed to high credit risks. Many borrowers who apply for P2P loans possess low credit ratings that do not allow them to obtain a conventional loan from a bank. Therefore, a lender should be aware of the default probability of his/her counterparty.
- No insurance/government protection:The government does not provide insurance or any form of protection to the lenders in case of the borrower’s default.
- Legislation:Some jurisdictions do not allow peer-to-peer lending or require the companies that provide such services to comply with investment regulations. Therefore, peer-to-peer lending may not be available to some borrowers or lenders.
More Resources
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FAQs
As with any high-return investments, there are risks with P2P lending. Default rates tend to be high with this class of loans, which can lead to losses for investors. Fees charged by the platforms may eat into any potential returns as well.
How profitable is peer-to-peer lending? ›
This means a solid portfolio of P2P loans can generate a steady stream of passive income. Higher Yields – Without question, the single most attractive aspect of P2P lending for investors is the potential for higher yields. A carefully curated portfolio of loans can potentially earn 10% annually or better.
How much can you borrow from peer-to-peer lending? ›
Maximum loan amounts vary depending on the peer-to-peer lender you're applying with. Some P2P lenders, like Prosper, allow qualified applicants to borrow up to $50,000, while others offer loans up to $500,000.
Is P2P credit legit? ›
P2P lending offers an alternative to traditional bank lending and can be beneficial for borrowers who may have trouble qualifying for a loan through a traditional lender. It can also offer borrowers with good credit scores a lower interest rate.
Can you lose money on peer-to-peer lending? ›
If the borrower defaults, lenders often lose their money
While some peer-to-peer loans are secured, they are most often unsecured loans. This means the borrower isn't borrowing against any collateral, and if they can't pay their loan, the lender loses their money.
What is the average return on peer-to-peer lending? ›
The research revealed that the newly developed framework of general characteristics-based portfolio policies (GCPP) can achieve an average rate of return of 8.86 to 13.08 per cent each year in an extensive data set of online loans collected from peer-to-peer (P2P) platform LendingClub.
What are the red flags in lending? ›
These may include, for example, unusual account activity, fraud alerts on a consumer report, or attempted use of suspicious account application documents.
Why did peer-to-peer lending fail? ›
Regulators also played a role. After LendingClub bought a bank in 2020 American watchdogs said the company had to set aside capital against peer-to-peer loans even after passing the exposure to investors. That made the business uneconomical.
Which P2P is best? ›
Compare the best P2P lending
| INTEREST RATES | REPAYMENT TERMS |
|---|
| Prosper | 8.99% to 35.99% | 2 to 5 years |
| Avant | 9.95% to 35.99% | 1 to 5 years |
| Happy Money | 11.72% to 17.99% | 2 to 5 years |
| Upstart | 7.8% to 35.99% | 3 or 5 years |
You typically need a score of at least 580-600 to get a P2P loan. However, the minimum credit score for a loan varies by lender.
LendingClub is a peer-to-peer—or marketplace—lender founded in 2007. As the largest online lending platform for personal loans, LendingClub has worked with over 3 million customers and funded more than $55 billion in loans.
Do you have to pay back peer-to-peer lending? ›
If you receive a loan, you might first need to pay an arrangement fee to the peer-to-peer platform. Then you pay back the loan, with interest, by making regular repayments for the duration of the loan agreement.
Can I make money from peer-to-peer lending? ›
P2P lending can provide a consistent stream of income in the form of interest payments and the principal amount is reinvested to get more interest, building a cycle. Depending on the loan terms, you may receive monthly payments, which can be especially attractive for those seeking regular income.
Who will give me a loan if no one else will? ›
If you need to borrow with no savings, high-interest payday loans and cash advances should be avoided. Better options are peer-to-peer lending, bad credit personal loans, and borrowing from family or friends.
How reliable is peer-to-peer lending? ›
So, is peer-to-peer lending safe? Like any investment, it does put your capital at risk. However, given the predictability of the repayments from borrowers and other safeguards in P2P, other forms of investment are often risker.
What are the problems with peer-to-peer lending? ›
The main peer-to-peer lending risks are: Yourself (psychological risk). Not enough diversification (concentration risk). Losing money due to bad debts (credit risk).
What are the pros and cons of P2P lending? ›
Peer-to-peer lending often offers lower interest rates and more competitive fees, but also carries higher investment risks compared to traditional lending and charges fees to both borrowers and lenders.
What are the red flags for lending? ›
suspicious documents; suspicious personally identifying information, such as a suspicious address; unusual use of – or suspicious activity relating to – a covered account; and.
Are peer-to-peer payments safe? ›
Peer-to-peer payment platforms are generally a safe and quick way to send money to friends and family. But you need to be careful because the transactions can't always be reversed, which also makes them a favorite for scammers.
