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
P2P lending can be riskier than traditional lending. That's because there's a higher risk of default, so lenders are more likely to lose money. In exchange for the additional risk, however, P2P lenders usually charge a higher interest rate, which can help offset the risk of losing money.
Is peer-to-peer lending illegal? ›
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 ...
What is the process of peer-to-peer lending? ›
In peer-to-peer lending, an investor lends money in exchange for interest on the loan payments. To get started, they sign up for a peer-to-peer lending platform such as Prosper or LendingClub. These marketplaces match investors with borrowers who are looking to take out a loan.
What is a peer-to-peer lending arrangement? ›
Image: Woman using laptop on sofa. Peer-to-peer lending is a form of online lending that allows individual investors to work directly with people or businesses seeking loans. These individual lenders may get a return on their investment, but they also shoulder financial risk for the loan.
What are the red flags for P2P? ›
Unusual Payment Requests: If someone asks for payment in the form of gift cards or through multiple small transactions, it's a significant red flag.
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 minimum credit score for peer-to-peer lending? ›
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.
How much money do you need for peer-to-peer lending? ›
The amount of money you need to participate in P2P lending varies depending on your chosen platform. Some platforms allow you to start with a relatively small investment, while others may have minimum investment requirements. Generally, you can begin investing in P2P loans with as little as $25 to $1,000 or more.
What is the maximum amount for a peer-to-peer loan? ›
The maximum limit for P2P lending in India varies based on regulations set by the RBI, typically capped at Rs. 10 lakhs per lender across all platforms.
How to borrow money from peer-to-peer? ›
Applying for a peer-to-peer loan is similar to other loans, and you'll typically take these steps:
- Check your credit. Review your credit report and score so you know which lenders you can qualify with. ...
- Shop around. ...
- Get pre-approval. ...
- Submit an application. ...
- Wait for loan funding. ...
- Receive the loan and begin repayment.
With most loans facilitated online, peer-to-peer lending can be faster and more convenient than going through a more traditional institution. Borrowers can often get funding within a few days, and investors can start earning returns almost immediately.
What is the average return on a P2P loan? ›
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.
Who funds peer-to-peer loans? ›
While the peer-to-peer lending platforms don't fund your loan directly, these companies do connect borrowers with investors. Plus, they facilitate the lending process from start to finish.
Why did P2P lending fail? ›
Lacking new investment, reserve funds get easily depleted, and platforms fail to fulfill their principal guarantee commitments. The lending base continued to shrink as investors lost confidence in the safety of P2P platforms. guarantee always hold.
Can you make good money with 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 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.
