Peer to Peer Lending (How Does P2P Lending Work?)

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Looking for a new investment avenue to boost your wealth? Or maybe you need to borrow money to open up your own business or afford a down payment on your first home? Whether you need a loan or want to capitalize on loans, peer-to-peer lending may be worth checking out.

In this post, we’ll break down what peer-to-peer lending is, how it works, and what pros and cons are associated with this lending option (for both investors and borrowers). Read all the way through for an in-depth look at peer-to-peer lending, or use the links below to skip throughout the article.

What is Peer-to-Peer Lending?

According to the Small Business Administration, peer-to-peer lending (aka P2P lending), is a way consumers and small businesses can access capital via the internet. Peer-to-peer lending is almost like taking a loan out from the bank, except that your bank is one of your peers. So instead of a credit union or big bank lending you money, it could be your neighbor, Seth, Claire, or any other individual or institutional investor.

P2P lending enables borrowers to access moderate capital to fund their business launch, consolidate their debt, or fix up their house, among other things, while individual investors can earn money through interest on the loans that they fund.

How Peer-to-Peer Lending Works

Now that you get the gist of peer-to-peer lending, let’s go over how P2P lending actually happens:

Whether you intend to lend or borrow money through a peer-to-peer lender, you’ll need to start with a lending platform, such as UpStart, Funding Circle, Prosper, or Lending Club. These platforms are where borrowers and lenders are partnered up so that they can create loan agreements.

If you’re an investor, you can choose which types of loans you want to invest in, like business or personal loans, for example. Additionally, investors can generally choose the amount of risk they’re willing to accept, as well as determine the timeline that they want to lend. Keep in mind, lending platforms each have their own qualifications for who can and can’t invest in loans through their marketplace, so you’ll have to be approved as an investor before you can start investing money in your peers.

If you’d like to open up a loan with a peer-to-peer lender, you’ll need to go through an application process provided by the lending platform of your choice. Each one works a little differently, but most include credit checks.

From there, you’ll either be approved or denied a loan. If you are approved, you’ll be presented with financing offers from different investors who may agree to fund your loan. Sometimes it can be a single investor, while other times, multiple investors will fund your loan, in which case, your loan payments and interest will be divided up among them.

Like any other loan type, peer-to-peer loans also have interest rates, which is how individual investors can turn a profit. Of course, the lending platform also wants in on the deal, so they’ll charge a small fee to the investors.

What can P2P loans be used for?

It depends on what type of loan you open and what loan types your lending platform offers. One of the most common uses for P2P loans is funding for small businesses. According to the House Committee on Small Business, the top peer lending platforms, Prosper and Lending Club, have helped investors finance $200 million in personal loans used for small business purposes.

Additionally, these platforms also offer the following loan types:

  • Lending Club offers personal loans, business loans, auto refinancing, and medical care financing.
  • Prosper offers several other loan types, including:
    • Debt Consolidation Loans
    • Home Improvement Loans
    • Short Term & Bridge Loans
    • Auto & Vehicle Loans
    • Small Business Loans
    • Baby & Adoption Loans
    • Engagement Ring Financing
    • Special Occasion Loans
    • Green Loans
    • Military Loans

Not seeing the loan type you’re looking for? There are several other lending platforms that offer P2P lending, more on that in a moment! Keep in mind that personal loans are known to be pretty versatile when it comes to what they can be used for. Debt consolidation, medical bills, and student debt are a few common applications for personal loan use.

Note: Like any other financial decision you make in your lifetime, it’s important to consider the various lending options you have available, whether that’s borrowing from a different P2P lender, or going with a different lending method altogether.

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Benefits and Drawbacks of P2P Lending

Depending on which side of the loan agreement you’re on, peer-to-peer lending has different benefits and drawbacks, which can also vary depending on your financial situation and lifestyle. Here are a few of the pros and cons you may experience as a participant in the peer-to-peer lending sphere.

For borrowers

  • Pro: Borrowers can obtain loans in smaller amounts.
  • Pro: Smaller peer-to-peer loans can typically be paid off faster.
  • Pro: The peer-to-peer lending process can be faster than conventional loans.
  • Pro: P2P loans are typically unsecured, so borrowers don’t need to use their property or assets as collateral.
  • Con: Borrowers can keep their anonymity from investors and only communicate with the lending platform as necessary.
  • Con: Peer-to-peer loans may have higher interest rates than conventional loans. However, certain economists argue that P2P loans offer savvier options when compared to credit card lending.

Important Note: Like any other loan type, your loan rate can vary based on your credit history, credit score, and other factors that influence your lender’s approval and offer process. In general, those with high credit scores are more likely to be eligible for better loan terms, including lower interest rates in some cases.

For investors

  • Pro: Getting started is simple and so is managing investments.
  • Pro: You can tailor your budget, profile, and risk assessment to your needs.
  • Con: Peer-to-peer loans are not insured or backed by the government, which could present substantial financial risk if the borrower defaults on the loan. However, P2P lenders are now required to register with the SEC to mitigate risk.

Investing in P2P loans presents some level of risk to investors, no matter which loan types they choose to fund, that’s just the nature of investing! No matter what investment avenue you choose—stocks, bonds, penny stocks, etc.—keep investment best practices in mind. For additional guidance and general investment advice, check out this post on how to start investing.

Special considerations to make about P2P lending

Before taking out a P2P loan, the Consumer Financial Protection Bureau recommends taking the following precautions:

  1. Review your income and spending.
  2. Look at your budget to determine what you can afford to pay, and how much you need to borrow.
  3. Check your credit and look for any discrepancies—mistakes on your credit report can reduce your score.
  4. Learn about your options by shopping around.

Top P2P Lending Platforms

We’ve already mentioned Lending Club and Prosper as two of the most popular P2P lending platforms, but they’re not the only options out there! Here are a few of the other major P2P lending platforms to choose from:

When choosing a peer-to-peer lending platform to work with, consider using resources like the Better Business Bureau and the Consumer Financial Protection Bureau to help you find the platform that’s best for your financial interests and security.

Some platforms even focus on financing loans for certain groups like small businesses, female entrepreneurs, and veterans, so it’s worth looking into a variety of options before making your decision!

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Key Takeaways

  • Peer-to-peer lending is a financing option that enables individual investors to offer loans to individuals seeking personal, business, auto, and other types of loans.
  • Peer-to-peer lending takes place on P2P lending platforms, which create a user-friendly space for both borrowers and lenders to make loan agreements for a fee.
  • Both borrowing and lending through P2P lending platforms come with several pros and cons to be aware of before moving forward.
  • There are several lending platforms to choose from—be sure to properly vet your options to find the solution that’s best for you!

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Small Business Administration | House Committee on Small Business | Experian | The Federal Reserve | LendingClub | | Consumer Financial Protection Bureau | The Balance | Better Business Bureau