What Is Peer-to-Peer Lending and How Does It Work? (2024 Guide) (2024)

Because P2P lending cuts out the conventional financial middleman of banks and credit unions, it has gained significant momentum among borrowers who might otherwise be turned away. By connecting with their peers, borrowers avoid the sometimes strict credit requirements and lengthy application process of traditional lenders. Investors benefit from potentially higher returns than other types of investments.

Convenience is another factor. P2P lending platforms are easily accessible online, allowing borrowers to secure loans and investors to fund loans from the comfort of their homes.

P2P loans might be more expensive than conventional business loans, personal loans or borrowing from your home equity. Applying online is convenient and often quick, but there may be delays as investors evaluate the opportunity.

The journey into P2P lending begins by registering on a platform of your choice.

Investors create a profile that includes their investment preferences, such as the loan types they want to fund and the amount they’re willing to invest. Once the borrower accepts, investors receive monthly payments consisting of principal and interest, minus any fees charged by the lending platform.

Borrowers create a profile, too, however, they must provide personal and financial information such as their credit score, income and the purpose of the loan. Once the profile is complete, borrowers can create a loan listing that outlines their borrowing needs. From there, they’ll specify the loan amount, the interest rate they’re willing to pay and the preferred loan term. Once lenders review the listing, they’ll decide whether to fund the loan partially or fully. Perspective borrowers may receive offers from multiple lenders.

P2P lending can be a viable option for borrowers with limited credit history, borrowers who prefer an online and streamlined application process, and investors seeking diversification and higher potential returns. Consider these different scenarios:

Scenario 1: Jane, the Aspiring Entrepreneur

Jane is a recent college graduate with a brilliant business idea but a limited credit history. Traditional banks are hesitant to extend a loan without substantial credit, leaving her struggling to launch her startup. Jane decides to use a P2P lending platform, where her innovative business plan and commitment to success outweigh her limited credit history. She managed to then secure the funding she needs to bring her entrepreneurial dream to life.

Scenario 2: Mark, the Busy Professional

Mark, a busy professional with limited time and a poor credit score, needs a personal loan to consolidate his credit card debt and simplify his finances. He prefers an online application process that allows him to complete the loan application during his lunch break. Because of multiple missed credit card payments, Mark’s credit score is below the minimum requirements of traditional lenders. He chooses a P2P lending platform, where he can easily apply for a loan online, receives offers from multiple lenders and selects the one that best suits his needs.

Scenario 3: Lisa, the Tech-Savvy Investor

Lisa, an experienced investor, is looking to diversify her investment portfolio. She’s drawn to the potential for higher returns offered by P2P lending. Lisa allocates some of her investment capital to fund loans on a P2P lending platform. By spreading her investments across multiple loans, she mitigates risk and enjoys the prospect of earning attractive returns that may outperform traditional savings accounts or bonds.

How To Stay Safe as an Investor

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. This is assuming you can find P2P platforms that still accept individual investors — companies such as LendingClub and FundingCircle now only accept institutional investors.

P2P lending has garnered significant attention in personal finance, offering borrowers and investors unique advantages and disadvantages.

Pros of P2P Lending

P2P lending offers opportunities that many traditional lenders won’t. Borrowers and investors may benefit from cutting out the middleman of traditional banks.

• Competitive interest rates for investors
• Accessibility and convenience
• Diverse loan options
• Potentially high returns for investors

Cons of P2P Lending

P2P lending is relatively new, which means it may not be allowed in your state or regulatory oversight is less stringent than with traditional financial institutions.

• Potentially high risk of default, leading to losses for investors
• Investment capital is tied up until the loan is repaid
• Limited regulatory oversight
• Fees

Entering the world of P2P lending might seem like a daunting prospect. With the proper knowledge and guidance, however, the process can be streamlined into manageable steps.

Step 1: Choose a Reputable Platform

The P2P lending landscape offers multiple platforms, each with unique features and offerings. However, the platform you choose becomes the foundation of your P2P lending experience. Trustworthy platforms prioritize the security of your personal and financial information. They also have established track records of reliability, reducing the risk of technical glitches or disruptions in your lending or borrowing activities, and offer transparent pricing information.

While there are numerous P2P lending platforms, there are a few well-known companies that have gained recognition for their reliability and user-friendly interfaces:

LendingClub is one of the largest and most established P2P lending platforms. It offers personal loans for borrowers and investment opportunities for institutional lenders. LendingClub has a user-friendly platform and a history of facilitating billions of dollars in loans.

Prosper is another reputable P2P lending platform that connects borrowers with investors. It provides a range of loan options and its transparent approach to fees and rates has earned it a solid reputation.

Upstart is known for its innovative approach to lending. It uses artificial intelligence and machine learning to assess borrower creditworthiness, making it an attractive option for borrowers and accredited investors looking for advanced risk assessment.

Funding Circle specializes in connecting small businesses with institutional investors. It has a global presence and is recognized for its focus on helping entrepreneurs access financing.

Step 3: Create an Account and Profile

Borrowers and investors should research the P2P platforms that align with their needs. For borrowers, consider factors such as interest rates, loan terms and fees. Investors should look at loan types, risk assessment methods and historical performance.

For Borrowers

Visit the chosen P2P lending platform’s website and click on the registration or signup option where you’ll provide general personal and financial information so the platform can assess your creditworthiness. Later, the company may initiate a hard credit pull once you provide additional details about yourself and your loan request. You may need to verify your identity through documents like a driver’s license or passport. This step helps ensure the security of your account.

For Investors

Click on the registration or signup option for investors on the chosen P2P lending platform’s website. During registration, you’ll have to provide personal and financial information, including your income and employment status.

After registration, you can create your investor profile, which includes your investment preferences and risk tolerance. Verify your identity through documents such as a driver’s license or passport. This verification adds an extra layer of security to your investor account.

Step 3: Explore Loan Listings and Terms

Once you’ve completed the steps above, lenders may assign an interest range based on creditworthiness. Borrowers may have the choice to set their rate within that range as well as their loan amount and term up to the maximums set by the platform. Investors then review those details, along with the loan purpose, before deciding whether to fund a portion, or note.

For Borrowers

Consider your financial needs carefully and only borrow what is necessary. Overborrowing can lead to unnecessary debt.

Set a competitive interest rate to attract investors while still considering your ability to repay the loan. Does the interest rate make sense for your circ*mstances? For example, if you’re borrowing money to consolidate credit card debt, is the interest rate of the P2P loan lower than what you’re paying now?

For Investors

Assess whether the loan aligns with your investment strategy and risk tolerance. You may do this by reviewing the borrower’s profile to gain insights into their credit history, employment and financial stability. A well-detailed profile can instill confidence in the borrower’s ability to repay the loan. Some P2P platforms provide risk scores or grades for loan listings. These scores can help you evaluate the level of risk associated with a particular loan.

Before delving into P2P lending, it may be wise to explore other financing options to ensure you’re making the right decision for your financial needs and goals. These alternatives can include personal loans through traditional banks, credit unions or online lenders.

Traditional Bank Loans

Unsecured personal loans are also offered by traditional financial institutions such as banks and credit unions. Their well-defined processes and regulations may contribute to a sense of security and offer lower rates.

The downsides may include strict eligibility criteria, including higher credit scores and income requirements. Borrowers with less-than-perfect credit or irregular income may need help obtaining bank loans. The application and approval process for bank loans can be time-consuming, sometimes requiring in-person visits.

Credit Unions

Credit unions are not-for-profit financial institutions owned and operated by their members. Unlike traditional banks, credit unions prioritize the financial well-being of their members and the communities they serve. Because of this mission, they may offer personal loans to members with thin or less-than-stellar credit.

To join a credit union, you typically need to meet specific eligibility criteria, such as living in a particular community, working for a specific employer or belonging to a particular organization. Like with some traditional banks, applying for a personal loan at a credit union might require an in-person visit. Credit unions may have a smaller branch network, which could be inconvenient if a location isn’t nearby.

Online Lenders

Like P2P platforms, online lenders are financial institutions that offer loans through digital platforms, often without the need for physical branches. These lenders leverage technology to streamline the application and approval process, making borrowing more accessible and efficient.

Online lenders can provide a swift and convenient application process, allowing borrowers to apply for loans from the comfort of their homes. Approvals are often fast, and some online lenders specialize in providing options for borrowers with less-than-perfect credit. Borrowers may not find personal loan rates that are any lower than those offered by P2P lenders, but they’re worth including in your research just like banks and credit unions.

Alternative Types of Loans

Personal loans, whether from a P2P lender or bank, credit union or online lender, aren’t your only option. Although it may be easier to qualify for a personal loan, home equity loans are sometimes possible for fair-credit borrowers. If you have good credit, compare P2P loan options against multiple types of loans and balance transfer and 0% APR credit cards.

• Home equity loans. Because they use your home as collateral, home equity loans and home equity lines of credit typically offer lower interest rates than P2P loans.
• Business loans. If you’re a small business owner considering a P2P loan, compare interest rates and fees against business loans from banks, credit unions and online lenders.
• Credit cards. If you need cash quickly, a credit card is typically a fast form of funding.

Joseph Widenhofer is a freelance copywriter and editor focusing on economic development, personal finance, schools and boards of developmental disabilities. He primarily works for the Golden Shovel Agency, a full-service virtual agency, as a short- and long-form content writer, as well as a website copywriter tasked with showcasing the positive impact of Economic Development Organizations and how they improve the lives of everyone in their community.

When he’s not writing, Joseph is going on adventures with his wife and dog, reading sci-fi and fantasy novels, listening to investing podcasts and regularly exercising. Connect with him on LinkedIn.