Peer-to-peer lending platforms seem to be popping up all over these days. That said, if you don't understand what this type of lending is, you are not alone. Below is a guide to peer lending.Keep reading to learn more about what it is, how it works, and the pros and cons for borrowers as well as investors.
What is peer-to-peer lending?
Peer-to-peer lending, often abbreviated as "P2P lending," is a relatively new form of securing new form of securing financing in which borrowers use a lending platform to match themselves with an investor who then directly finances their loan.
Also known as "marketplace lending," this form of investment is becoming increasingly popular among borrowers who are considered a credit risk by traditional lending institutions and individual investors who are looking for new investment opportunities.
How does P2P lending work?
Now that you understand more about how this type of social lending works, the next step is to look at an overview of how the P2P lending process works. In light of that, we've laid out both sides for you below:
How it works for borrowers
- Fill out a loan application: This step involves checking your credit score; however, depending on the lender, it can either be a hard or a soft inquiry.
- Accept your interest rate: Based on your credit history, you'll be given an interest rate for your loan. If it's acceptable to you, your loan request will be posted on the lending platform.
- Wait for investors to decide whether to fund your loan: The investors on the lending platform will be given a chance to review your loan request and decide whether or not to fund it. At this stage, your loan could be funded by one investor, multiple investors, or not funded at all.
- Proceed with repayment: If your P2P loan is funded by a P2P lender, as a borrower, you'll be expected to make regular payments on it until it is paid in full.
How it works for investors
- Select a P2P lending platform: Some lending platforms assign each loan request a grade based on the strength of the loan application. It's important to do your research on each P2P lending platform and find a peer-lending platform that works for you.
- Review loan requests: It's up to you to review each loan request and determine whether or not it is a viable investment opportunity.
- Fund a loan request: Most P2P lending platforms will allow you to fund loan requests by connecting your bank account to the platform.
- Wait for repayment: You'll receive earnings with each payment on the loan, until you have been repaid in full.
What are the pros and cons of peer lending for borrowers?
Here’s a closer look at the pros and cons of P2P lending for borrowers:
- You may face relaxed qualifying standards: If you've been denied by a traditional lender, like a bank or credit union, you may have an easier time being approved by a P2P lender.
- You may be able to secure a lower interest rate: Since there is more competition between peer lenders, borrowers may be able to secure a lower interest rate than they would at another financial institution, which can mean a lower monthly payment
- Peer loans still come with fees: You may still have some fees to contend with, like a loan origination fee.
- Peer loans are generally small loans: Since peer loans are usually unsecured personal loans, they're generally on the smaller side. If you only need a small loan, this won't be an issue. But, if you need a large amount, it may need to come from multiple sources.
What are the pros and cons of peer lending for investors?
Investors have their own pros and cons as well:
- You may see higher returns: Depending on which loan requests you decide to invest in, you may see higher returns than you would with another form of investment.
- You have the opportunity for passive income: P2P lending is generally a pretty passive investment. It certainly requires less sweat equity than other forms of real estate investing.
- There are a lot of risks: Borrowers who use P2P lending platforms have typically been denied by a traditional bank or credit union, which means they are more of a risk. However, in addition, these platforms are often uninsured and unregulated.
- Peer lending may not be available to you: Some states have legislation banning these social lending platforms. Peer lending may not be an option for every individual investor.
The bottom line
Getting a peer loan is a unique way for borrowers to receive the real estate financing they need, and it is also a way for investors to explore new investment opportunities. However, it's not right for everyone. If you're going to go this route, you'll need to do your research on the P2P lending company as well as any applicable loan requests. When in doubt, it never hurts to consult a financial advisor before investing or borrowing from a new source.