Throughout your life, you’ll come across times when you need a loan or new credit. And you’re not alone in this. According to TransUnion, the average American had $11,687 owing in personal loans as of the second quarter of 2024. Loans are simply a necessity sometimes. But just because you need a loan doesn’t mean you can get a loan. If you have poor credit, no credit profile, or have lost your job, you might struggle to get approved for a loan when you need it most. That’s where peer-to-peer lending comes in.
What is Peer-to-Peer (P2P) Lending?
Peer-to-peer lending (P2P), sometimes referred to as social lending, crowd lending, or debt crowdfunding, is a process by which people can borrow money directly from other individuals without involving a bank, credit union, or other financial institution. However, it’s still more formalized than simply asking money from a friend or family member. This is a legitimate form of borrowing with an application process, a contract, and terms and conditions.
P2P lending uses websites or platforms to connect individual lenders with individual borrowers. Using the P2P platform, investors and borrowers can securely exchange money.
How Does Peer-to-Peer Lending Work?
Each platform varies in how it operates and the terms and rates it applies. However, almost all these sites have options that cater to people of all credit scores (high and low).
Investors can create an account, add funds, and choose individuals to loan money to. The investors get information about the applicants, such as how much they need, how long a repayment term they’d like, and their creditworthiness. The creditworthiness ranking allows investors to choose how much risk they take on. Typically, applicants with lower credit scores carry a higher risk of defaulting, so they can be charged a higher interest rate. The investor takes on a risk with these borrowers but also has the potential to earn more money.
Borrowers may receive multiple bids on their loan submissions from several investors. They can then choose the loan that best suits their needs.
Some popular and well-known examples of peer-to-peer lenders are Kiva, Funding Circle, and Lending Club. Lending Club was the first P2P lender to register its services with the Securities and Exchange Commission.
How to Apply for a P2P Loan
Applying for a peer-to-peer loan is fairly straightforward. You’ll follow these steps:
- Create a profile on the P2P lending platform of your choice.
- Submit your personal information, financial details, and desired loan details. The platform may require a credit check.
- The platform will assign you a creditworthiness score.
- The platform will match you with lenders.
- Lenders will send you loan offers with varying interest rates.
- You’ll pick an offer and sign a contract.
- The platform will issue you the funds.
- You’ll continue to make regular loan payments through the platform based on the loan’s contract.
The Benefits of Peer-to-Peer Lending
Some of the advantages of getting a peer-to-peer loan are:
- Easier Approval: P2P loans are often easier to secure, especially for those with poor credit scores who may be turned away by a regular financial institution.
- Faster Approval: Peer-to-peer lending sites operate entirely online and use automated systems, so approvals are typically very fast.
- Better Interest Rates: A peer-to-peer loan may offer a better interest rate than you could secure at a bank or credit union.
- Flexible Repayment Terms: Borrowers can often request unique or specific repayment terms that a conventional bank wouldn’t grant.
- Payday Loan Alternative: If banks and credit unions won’t give you a loan, it can feel like the only option left is payday loans. However, payday loans are highly predatory, with an average interest rate of 300% or more. P2P loans are, therefore, a better alternative to payday loans.
- Multiple Loan Types: Peer-to-peer lending allows you to get many kinds of loans, including personal loans, auto loans, small business loans, home renovation loans, and more.
For lenders, the main advantage of P2P lending is the potential for greater returns than investing in other ways, such as the market or real estate.
The Disadvantages of Peer-to-Peer Lending
Some of the disadvantages of peer-to-peer lending are:
- For the Borrower:
- The P2P platform may charge the borrower fees for using its services, which increases the overall borrowing cost.
- Banks and credit unions often have resources and advisors to help individuals struggling to repay their loans. P2P platforms don’t usually offer this support.
- For the Investor:
- Often, peer-to-peer loans can be a risky investment. The borrowers who turn to P2P loans may have been turned away by banks because they’re seen as risky borrowers, which means there’s an increased chance of defaulting on the loan. The lender takes on all the risk with a P2P loan, and if the borrower defaults, that money is gone.
- There are no government protections or insurance for P2P lenders, so your investment isn’t protected.
- The peer-to-peer lending platform may charge fees, which can eat into profits.
Is a Peer-to-Peer Loan Right For You?
If you’re struggling to get approved for a loan from a traditional financial institution, a P2P loan might be a good alternative. Peer-to-peer loans may come at slightly higher interest rates, but they’ll still be better than payday loans or maxing out your credit cards.
As for investors, the peer-to-peer lending space is risky. There’s an opportunity for significant returns, but it comes at a risk. You’re usually lending money to people with poor credit, and the loan is unsecured.
If you wish to experiment with P2P lending, consider doing it with a small percentage of your investment portfolio to reduce your overall risk exposure.
Overall, peer-to-peer lending is a fascinating space that certainly fills a need in the market.
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