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
Because, unlike depositors in banks, peer-to-peer lenders can choose themselves whether to lend their money to safer borrowers with lower interest rates or to riskier borrowers with higher returns, in the US peer-to-peer lending is treated legally as investment and the repayment in case of borrower defaulting is not ...
Is peer-to-peer lending worth it? ›
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.
What is the peer-to-peer lending system? ›
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.
Who is the biggest peer-to-peer 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.
What happens if you dont pay back a peer to peer loan? ›
A traditional bank might offer support such as a payment plan or a longer period to repay the loan before sending a loan to collections. However, peer-to-peer lenders may send a defaulted loan to a collection agency in as little as 30 days. If your payments are late, a P2P lender may raise interest rates or add fees.
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.
What credit score do you need for a peer to peer loan? ›
Compare the best P2P lending
| INTEREST RATES | MIN. CREDIT SCORE |
|---|
| Prosper | 8.99% to 35.99% | 560 |
| Avant | 9.95% to 35.99% | 580 |
| Happy Money | 11.72% to 17.99% | 640 |
| Upstart | 7.8% to 35.99% | 300 |
Best Overall Prosper
It accepts borrowers with credit scores in the “fair credit” range and also allows joint applicants. And Prosper has outstanding customer reviews. Prosper is our choice as the best overall peer-to-peer lender because it works with borrowers with fair credit and offers a wide range of loan amounts.
What are the problems with peer-to-peer lending? ›
Disadvantages for the borrower
You may have to pay additional fees on top of the interest rate charged for the loan. You may have to pay a higher interest rate than that charged by traditional lenders if you have a poor credit rating. You may not even get a peer-to-peer loan if your financial profile is very poor.
Is there risk in 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).
Is P2P lending safe? Peer-to-peer lending is riskier than a savings account or certificate of deposit, but the interest rates are much higher. This is because those who invest in a peer-to-peer lending site assume most of the risk that banks or other financial institutions normally assume.
How to get into peer-to-peer lending? ›
There are three main steps:
- Open an account with a P2P lender and pay some money in by debit card or direct transfer.
- Set the interest rate you'd like to receive or agree one of the rates that's on offer.
- Lend an amount of money for a fixed period of time – for example, three or five years.
Monthly Income – Investors are paid every month when borrowers make payments on their loans. 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.
What is the limit of peer to peer loan? ›
RBI guidelines allow any individual, HUF (Hindu Undivided Family), firm, society, or company to participate in a P2P lending platform. As per new guidelines, the RBI raised the investment limit for individuals by five times to Rs 50 lakhs.
Is peer to peer lending still available? ›
Still, opportunities for individual investors to fund peer-to-peer lending remain, although as with any investment, you'll need to do your due diligence. Likewise, borrowers should shop around to determine where they can get the best terms, whether from a fintech platform or elsewhere.
Is it legal to use peer-to-peer sharing? ›
Sharing work or media through a peer-to-peer (P2P) network is legal if you own the copyright, thus you own the right to determine if and how that work is distributed. For example, you can write and produce an original song and make it available for others to download for free through a P2P file sharing program.
What states allow peer-to-peer lending? ›
Forty three states are open for investing through Lending Club: Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota,Mississippi, Missouri, Montana, Nebraska, ...
Is peer-to-peer processing legal? ›
Building a P2P network is perfectly legal. Using a P2P network is also perfectly legal. Sharing content on a P2P network is also completely legal if the files are not copyright protected. Sharing files like music and movies is illegal.
What are the rules for P2P lending? ›
The maximum amount that a lender can lend across all P2P platforms is capped at ₹50,00,000. This limit is subject to the condition that such investments are aligned with the lender's net worth.
