What is Peer-to-Peer (P2P) Lending?
Peer to peer (P2P) lending is a way for individuals to get loans from other individuals without the need for a bank or other financial institution. P2P lending is a relatively new form of financing, existing since 2005.
Detailed Look at Peer-to-Peer (P2P) Lending in Personal Finance
Websites like Prosper exist that allow borrowers to finance loans directly from individual lenders. For example, a borrower might need $10,000 to refinance their credit cards, and a website like Prosper would allow, hypothetically, 100 lenders to each lend $100 to the borrower as one $10,000 loan. Each month, the borrower would pay principal and interest, and each lender would get their share of the monthly payment.
P2P lending platforms give lenders, also known as investors, the ability to see various metrics about potential borrowers, including insights on their credit history, employment, salary, location, how much money they're seeking, and why they seek to borrow money. P2P lending platforms generally assign a risk rating to each borrower and an interest rate so that the lenders know what their returns will be and how risky the borrower may be.
As a borrower, you might go to a P2P lending platform to obtain money if you struggle to obtain a loan from a financial institution such as a bank. P2P lending platforms generally use unsecured personal loans that allow you to spend the money in many different ways, though you may have to disclose how you intend to use the money.
What is the History of Peer-to-Peer (P2P) Lending?
Originally, P2P lending was designed to provide credit access to individuals who may not qualify for loans from banks and other financial institutions. Later, P2P lending became available to allow individuals to pay off credit card debt at lower interest rates, refinance medical debt, start a business, finance home improvements and auto loans, and other options.
For applicants with high credit scores, it's often possible to get interest rates on loans that are less than what a typical bank would offer. However, those with poor credit scores may find that interest rates are significantly higher with P2P lending personal loans than what they might find at a financial institution.
Lenders wanting to invest in P2P loans can earn interest on their cash at a much higher rate than possible with a bank account, though with increased risk such as borrowers defaulting.
What Fees Do Peer-to-Peer (P2P) Lenders Charge?
P2P lending platforms may charge fees to both the lender and the borrower. Because of this, it's important to read the terms of the loan you invest in or the loan you apply to take out before doing so. Some platforms will charge you a fee each time you receive a payment if you're a lender, and as a borrower, you may pay a fee when the loan is first disbursed to you.
What Are Peer-to-Peer (P2P) Loans Used For?
P2P loans can be used for several reasons, which include:
- Refinancing debts into a single personal loan
- Refinancing one or more credit cards
- Funding a business
- Buying a car
- Paying medical debt
- Financing home improvement
Some P2P lending platforms will allow you to borrow money for just about anything, as long as you disclose what you're using the money for. But, generally speaking, you can't borrow money to gamble, invest, or do illegal activities.
Is It Safe to Invest in Peer-to-Peer (P2P) Lending?
As with any investment, P2P lending has the risk of you losing your money if your borrower stops paying their loan and defaults. However, many P2P lending platforms give you the ability to filter out potential borrowers that you may find too risky, such as allowing you to filter those who have low credit scores, recent credit delinquencies, high debt to income ratio, short employment history, and so on.
By being able to filter out potential riskier borrowers, you may increase your return on investment over time.
How Do You Invest in Peer-to-Peer (P2P) Lending?
To invest in P2P lending, you'll want to find a P2P lending platform that you meet the requirements for, and that has agreeable terms.
Some P2P lending platforms include:
This article discussed P2P lending and investing in P2P lending. Always do your due diligence before making investment choices and discuss questions you may have with a financial advisor you trust.