Peer-to-peer (P2P) lending also referred to as ‘crowd lending’ or ‘social lending’ is a form of lending where repayable financial assistance is rendered to individuals in need without involving a financial institution like banks, credit unions etc.
It is a form of financial service where borrowers in need are matched with lenders interested in doing the same.
P2P lending was sought after to curb the stress that borrowers reportedly go through when they try to get a loan from traditional banks. From the excessive documentation to unfriendly interest rates and other eligibility requirements that banks insist on. As a result, P2P lending became more popular.
Loan applicants with low credit scores, small business owners and other categories of borrowers, also see P2P lending as the suitable alternative to banks.
Peer-to-Peer lending transactions are facilitated by online lending platforms. These platforms set the lending rates, the terms and conditions for borrowing/lending, safely connect the borrowers to lending partners or investors as some people choose to call them as well as oversee the entire transactions process.
A lot of investors also prefer the P2P option to put their funds into as they tend to get a higher Return on Investments (ROI) than what traditional institutions offer.
How does Peer-to-Peer lending work?
Peer-to-Peer lending is a financial transaction where borrowers and lenders, also known as investors are directly merged by online regulators to offer financial assistance to individuals and businesses in need of quick cash.
Instead of getting loans directly from the bank, credit bureaus or any other traditional financial institution, borrowers get funds from fellow individuals who are willing to lend to them. It is not also expected of a single lender to provide them with 100% of their required funds. The online platform can merge them with multiple lenders to arrive at the amount that they need and apply for.
What are P2P loans used for?
There are several ways that you can put the funds gotten from P2P loans to use. Lenders do not dictate or insist on how the borrowers choose to spend the money. Although, they are usually meant to cover basic and simple expenses. Some of them are, but are not limited to;
- Start-up funding for small business enterprises
- Emergency bills/purchases
- Inventory purchases to stock up on goods
- Opportunities for business growth and expansion
- To pay a personal debt or offset expensive loans before they turn bad loans
- Other Personal expenses etc
How do applicants qualify for Peer-to-Peer loans?
Although the processes involved in P2P lending are less tedious than those from traditional banks, there is still the involvement of some processes and criteria for eligibility. Before an application is certified okay to borrow, lenders pay attention to the following major requirements amongst others;
Just like in every other form of lending, an applicant’s credit history is the biggest determinant factor to qualify for a P2P loan. More often than not, a credit score of above 600 makes you eligible to borrow. Although, some lenders may insist on a minimum score of 640 and above. The higher your credit score, the faster you get your application approved at a lower Annual Percentage Rate (APR).
As you apply for a Peer-to-Peer loan, another piece of information you would be required to provide is your debt-to-income ratio. Lenders highly consider this variable. For your application to qualify for the lowest available APR, some lenders may insist on a debt-to-income ratio of less than 50%. This criterion also determines how fast your loan application is approved as no one wants to risk giving money to someone with an extremely poor debt-to-income ratio.
Lenders also take their time to take a look at applicants’ businesses to ascertain that they are worthy of the required partnership. They want to believe that your investment is a solid one and not a one-hit-wonder. They may also ask to look at your book to check out your annual revenue or sales as well as years of operations.
P2P lending steps for borrowers
Study the loan contract
The first step for an applicant is to diligently study contract terms and conditions. Ensure you understand the interest rates, the lender operates in your locality as not all lenders can operate in every state, and you are not under pressure to borrow more than you need. Consider a moderate amount that you can pay back on time.
This is the 21st century, so loan applications like most applications are online. Upon understanding and being satisfied with the loan terms, you may then proceed to fill out an e-application form. At this stage, you would also provide the lender with copies of your tax returns and recent bank statements which may include income such as pension payments or child support etc.
Wait for your terms
Upon submission of your application, the lender reviews it and decides if you qualify for the loan or not. Where you qualify, they will give you a set term to repay. It is usually within five (5) years or less. The maximum amount you can get on a P2P loan is usually not more than $50,000.
What does P2P lending mean to investors?
Individual investors can open an account with a lending platform and invest some amounts for P2P loans. When an applicant indicates interest in getting loans, the online platform matches them with investors for credit after all necessary verifications.
Peer-to-Peer lending offers higher ROI to investors than traditional investments but at the same time, is riskier. This is a result of borrowers’ default rates.
As an investor, you have control over the type of loan you want to offer and how much you wish to invest in each.
There is also the advantage of speed. Lenders can invest in a loan request from an entirely different location from the borrower’s.
They also gain interests as high as 10% ROI. This is pretty good for the lender.
Removing banks as the middleman in the loan transactions process via the P2P lending alternative has made lending more profitable to the investor and borrowing cheaper for the borrower. Similarly, just as many borrowers prefer to borrow from P2P platforms as against the bank, many investors also prefer to partner and invest their resources in peer-to-peer.
Types of peer-to-peer loans
Many peer-to-peer loans are unsecured, being that they do not require the borrower to pledge collateral for securities. Some of the popular P2P loans are;
Just like the name implies, a business loan is one taken to solve the financial-related problems of your business. If you are a start-up, and you are looking at upscaling, P2P may be one of your many options to expand.
You can also use the loan to stock up on your inventory, as well as to improve on your logistics.
Peer-to-peer lending can also cover the borrower’s personal needs like vehicle purchase, mortgage, medical bills etc.
Depending on your credit score, the interest rate on personal loans may extend from 5% to 36%. The amount range for personal loans that last for two to five years is usually between $2,000 and $35,000.
Funding education through the P2P alternative can be a great alternative to other forms of borrowing. The peer-to-peer is particularly great for students who do not qualify for private or federal student loans.
Students that apply for student loans are usually allocated the funds in a lump sum and they now independently distribute the same according to their school expenses and fees. Short-termed student loans can range from one to three years.
Is P2P lending safe?
Generally, peer-to-peer lending is safe for both the investor and borrower. This is because of the fact that these online lending sites are duly registered with the United States Securities & Exchange Commission. They are also known to work with banks that are insured by the Federal Deposit Insurance Company (FDIC) who release the money to borrowers and hold unto uninvested funds.
They also ensure the safety of borrowers and investors alike by;
- Conducting due diligence and vetting borrowers’ applications properly. They also ensure transparency by displaying the same ratings given to borrowers to investors.
- Providing buyback guarantees (insurance) to the investors. In a case where the borrower defaults in repaying, the investor is compensated by the insurer.
- Matching a loan request with multiple investors. This is to ensure that not a single investor lends the borrower 100% of the loan. When a loan application is sent and certified okay, different lenders contribute in bits to math up the total amount requested. That way, investors don’t have to part with a huge sum at once.
Does peer-to-peer lending involve any risk?
Just like any other form of investment, peer-to-peer lending has its own pockets of risk. Some of which are;
- Loan repayment default. A borrower’s failure to pay back their loans as at when due is one of the risks involved in investing in P2P lending. This act could affect the lender.
- The bankruptcy of online lending site. This happens when the site approves loan applications that are more than its investors. This makes it impossible for the site to fund all its request.
- Cybersecurity threat. As a result of the online nature of P2P lending, the site stands the risk of being attacked by cybercriminals. Hackers may find their way into the site and steal vital financial information or even move funds.
Features of the Peer-to-Peer lending
- The elimination of financial institutions as the middleman. A P2P loan application is matched to a lender or investor, and not the bank. Peer-to-peer lending was designed to eliminate financial institutions like the bank and credit union from the entire loan process. It was meant to make the process seamless to both the borrower and investor. However, this does not stop the online lending platform from ensuring all due diligence.
- The pre-qualification process does not affect your credit score. Most times, many P2P lending sites already have available pre-qualifications. As a result, applicants do not have to worry about hard credit checks. The pre-qualification also saves the applicant time. As with it, you know you are eligible for funds and can go ahead with the process.
- An excellent credit score is not required. Unlike most financial institutions that insist on an excellent credit score from applicants, the peer-to-peer alternative okays the ‘not-too-great’ credit scores at relatively low rates. It is also a great option for people with a short credit history or a higher debt-to-income ratio.
- Helps boost credit scores. Just like the loan you get from the bank or any other financial institution, prompt payment of your P2P loan will boost your credit score and improve your chances of getting loans at better rates in the future. This is because of the fact that some online lending platforms send reports to credit bureaus. So, your performance, as a borrower is not unnoticed. When this happens, it positively affects your credit score and history.
- Allows for a more human approach to financing. This feature is another reason why P2P lending is a great alternative. A lot of borrowers are more comfortable with getting loans from online lending platforms than traditional lenders like banks because they prefer a more human, interactive and community-based approach.
This is because, speaking with a bank staff for example, usually seem more like speaking with the institution, and not an individual. Their responses are always almost predictable as they have rule books to walk by. But the peer-to-peer alternative allows the free flow of feelings and emotions, and create room for mutual understanding.
Some popular P2P lending sites
There are numerous peer-to-peer online lending sites or lending marketplaces as some people call them that attend to new loan requests and loan refinancing. It is always advisable to do your research (DYR) on several existing sites to understand the one that best meets your financial needs before you decide on which to be your financial partner.
Some of the popular peer-to-peer lending sites are;
- Funding Circle