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.
What happens if you don't pay a P2P loan? ›
If your payments are late, a P2P lender may raise interest rates or add fees. If you plan to borrow using a P2P loan, know the terms you are signing up for. A traditional lender could be more lenient with an unpaid loan, but a P2P lender will likely take action against a defaulted borrower more quickly.
What are the problems with P2P lending? ›
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.
How much can you make from 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.
What are the red flags in lending? ›
These may include, for example, unusual account activity, fraud alerts on a consumer report, or attempted use of suspicious account application documents.
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.
Can you lose money in P2P lending? ›
With P2P lending, you make money based on the interest rate you set or agree to. Typical interest rates can vary, depending on the risks you're willing to take. Even higher interest rates can be found, but again, this implies a much higher risk of losing your money.
How can you lose money in P2P payments? ›
From compromised accounts to fraudulent transactions, using a P2P service opens you to some risk of losing your money to a scammer.
Do you have to pay back peer-to-peer lending? ›
If you fail to make the repayments on a peer-to-peer loan, the provider may pass the debt on to a debt collection agency, or it may take you to court. This could affect your credit report.
Why did peer-to-peer lending stop? ›
However, the coronavirus crisis and increased scrutiny from regulators such as the Financial Conduct Authority – which has dubbed P2P a “high-risk investment” – have caused huge turmoil for the industry and led to some players quitting the market.
Many P2P platforms lacked professional risk management and sufficiently large reserve funds. Therefore, when there was a shortage of new investors or economic downturns, a small number of borrower default cases could quickly deplete the reserve funds and cause panic among lenders.
What is a risk of using P2P? ›
Sharing files using peer-to-peer (P2P) software is efficient. But if you misuse P2P software, you expose yourself to the following risks: Exposing your hard disk to others. Contracting computer viruses. Infringing copyright.
What is the maximum amount for a 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.
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.
What is the largest peer-to-peer lending platform? ›
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.
Are peer-to-peer payments safe? ›
Peer-to-peer payment systems encrypt and shield your financial information, and most companies have support teams and fraud monitoring procedures in place to help solve issues involving unauthorized access. The technology these platforms use is secure, but there are scams centered on Peer-to-peer payments.
Which of the following are red flags when interacting with a P2P seller? ›
Stay alert when interacting with a P2P seller.
Red flags include: The seller asking you to cancel the order after you've already paid. The seller asking to communicate outside the P2P platform. The seller asking you to trade outside the P2P platform.
What is the average interest rate for peer-to-peer lending? ›
