Many people assume there’s only one source of borrowing – a traditional bank. While banks are a major source of lending, there are other options for borrowing. One of the most popular options is peer to peer lending.
Let’s explore what peer to peer lending entails.
What are Peer to Peer Loans?
Simply defined, peer to peer loans are a type of debt financing where individual investors loan money to individual borrowers. In peer to peer to peer (P2P) lending, lenders and borrowers enjoy freedom and control over the terms of a loan.
There’s no intervention of intermediary financial systems. Peer to peer loans is a popular alternative to taking out a traditional loan from a bank.
Most of these loans are unsecured personal loans, which borrowers can use for various purposes, including debt consolidation, home improvement, or starting a small business.
So, how does peer to peer lending work?
P2P lending works much like crowdfunding. Individual lenders usually referred to as “Investors” by the industry, deposit funds into an account from which they will give out loans to borrowers.
A borrower can apply for a loan either through one investor or across several different lenders. These transactions are facilitated by a central website, which hosts the investor’s account, determines interests rates, and takes care of all of the funds’ transfers.
If you are borrowing a $3,000 loan, for example, you might apply through Lending Club, one of the popular P2P lending sites. Your loan, if approved, might come from a single fairly large investor, or you might get $500 each from six different lenders.
Either way, you’ll see only one fixed loan, while each of the investors in the latter case would see $500 note on their account denoting their share of the loan.
P2P lending sites operate differently from each other when it comes to evaluating individual borrowers and connecting lenders with potential borrowers.
P2P Loans for Borrowers
If you are looking to borrow with a P2P loan, you need to choose a lender that meets your needs and start the application process. You’ll normally have to provide personal details. You may also be asked about why need the funds.
While most P2P loans are personal, lenders may offer different packages. The lender will review your credit score. If you qualify for a loan, investors are allowed to fund it.
The funding process can take a couple of days to several weeks depending on the lender. Once your loan is funded, you’ll receive the funds electronically. You’ll be required to make repayments over 36 to 60 months with automatic electronic payments.
The best thing about P2P loan repayments is that there are normally no penalties, and this helps you save money on interest. It’s worth noting, however, that defaulting on your loan can have a negative impact on your credit rating.
In fact, most P2P lenders report your activities to credit bureaus. This can help you get a loan on better terms in the future. It’s advisable to remain disciplined in making payments to protect your credit.
Pros of P2P Borrowing
- Fast processing
- Affordable interest rates
- Fixed monthly payments
- Less strict requirements compared to bank loans
- Loans can be used in different ways
- Check rate without compromising credit score
- Most loans are unsecured
- Automatic repayments with no penalties
Cons of P2P Borrowing
- Defaulting on payments can hurt your credit score
- High-interest rates if your credit is below average
- Can’t normally borrow more than $50,000
- Some lenders charge high fees, including up to 6% origination fees
P2P Loans for Investors
If you want to be a peer to peer lender, you need to choose a lending platform based on how well it suits your personal needs. You can determine that by evaluating data such as interest rates, lending caps, and credit-check process.
Once you identify a suitable P2P lending platform, you’ll need to create and put money in an account. Most platforms require investors to have a minimum of $1,000 in their account. Others may require more.
After funding your account, you’ll need to choose loans that will be suitable investments. If you want to handle things manually, you can view loans based on borrower data, which may include:
- Credit score
- Loan type
- Purpose of loan
- Interest rate
Some sites don’t show actual credit score, but a grade such as A, B, or C. They assign interest rates based on the grades. If you don’t want to handle each loan individually, you can also choose to automate lending policies.
With some P2P platforms, you can set policies by which your account with award loans with metrics like credit score, type of loan, size of the loan, and expected repayment date.
You’ll normally receive a note representing your share of a given loan, thanks to the fact that several investors can fund a single loan. When the borrower makes payments, you’ll receive money into your account or in your specified bank account.
Details may vary from platform to platform, but this is generally how investing in peer to peer lending works.
Pros of Peer to Peer Investing
- Higher yield compared to savings or Certificate of Deposit (CD) accounts
- Most P2P lending sites allow you to diversify your loan portfolio automatically
- Access to alternative investments besides stocks and bonds
- The sense of social good by lending directly to peers
Cons of Peer to Peer Investing
- Risk of losing your investment should borrowers default
- Less liquidity compared to stocks or bonds as the loans are normally long-term (3-5 years)
- Not insured by the Federal Deposit Insurance Corporation (FDIC) like a CD or savings account
- Some platforms can be accessed only by accredited investors
Top Peer to Peer Platforms
If you need a loan, you should evaluate several P2P lenders to find the most affordable loan based on your needs. You may have heard about Lending Club and Prosper, as they are the most popular, but there are numerous other P2P platforms in the United States market.
Let’s explore some of the best peer to peer lending platforms:
Established in 2007, Lending Club is the largest P2P lending site in the U.S. It had funded about $16 billion worth of loans by the end of 2015. The site connects investors and borrowers to put together loans from which both parties will benefit.
If you need a loan from Lending Club, you have to apply on the website. It will take you a few minutes to complete the application. Once you’ve applied for a loan, the site allows you to link up to Credit Karma where you can start monitoring your credit.
You should expect to receive your loan in at least three days. You can get up an unsecured personal loan up to $35,000. The interest rates range from 6.95% APR to 35.89% APR depending on your credit score.
Prosper was established in 2005 and currently has over 2 million members. It has funded at least $5 billion worth of loans to date. Some of the investors in Lending Club are large institutions like Black Rock, Sequoia Capital, Credit Suisse NEXT Fund, and Institutional Venture Partners.
You can get a loan worth $2,000 to $35,000 from Prosper. You can use the loan for virtually any purpose, including home improvement, debt consolidation, buying a car, or financing a business.
Moreover, if you need money to adopt a child, to finance a renewable energy-based system, or buy an engagement ring, Prosper has got you covered.
You can pay the loan in three to five years, and the interest rates range from 5.99% to 36% depending on your Prosper Rating. This rating is determined by taking into account your credit score and credit profile, loan amount, and loan term.
These are fixed-rate installment loans, so the loan repayment should be completed by the end of the loan term. It’s worth noting that Prosper charges origination fees, but you don’t have to worry about repayment penalties or hidden charges as there are none.
Upstart is the brainchild of three former Google employees. It’s not only a P2P lending platform but also an intuitive application for financial institutions.
One thing that sets Upstart apart from other P2P lending platforms is how they evaluate risk. While most lenders will look at your FICO score, Upstart has developed a system that uses artificial intelligence and machine learning to determine your risk.
As a result, Upstart has experienced lower loss rates compared to its competitors. Upstart also boasts an excellent TrustPilot rating, making it one of the most reliable P2P lending platforms.
You can get a loan between $1,000 and $50,000 payable in 36 to 60 months. Interest rates start at 8.85%. There are no prepayment penalties. Besides reviewing your FICO score and credit history, Upstart also considers your education, profession, and job history to determine your creditworthiness.
This P2P lender says that their borrowers save at least 24% compared to other credit card rates. You can also invest with Upstart, and investing with them is quite intuitive as well.
One of the interesting features you’ll find valuable as an investor is that the platform allows you to set up a self-directed IRA using the investments from P2P lending.
Moreover, the platform allows you to set up automated investing by selecting a particular strategy and automatically depositing funds.
It is worth noting that college-individuals with a weighted average loan amount of over $83,000 make up about 80% of Upstart borrowers.
At least 75% of these borrowers are paying off credits cards. So you have a rough idea of who you’ll be investing in if you decide to put your money in Upstart. Moreover, Upstarts claims that their business has grown three-fold over the last three years, thanks to their propriety underwriting model.
Final Thoughts on Peer to Peer Lending
If you need funding to start a business, renovate your home, buy a car, or to consolidate your debts, but no bank is willing to help, you could use peer to peer lending. If you want to add another investment to your portfolio, peer to peer loans may be a great option.