Peer-to-peer lending is a convenient way of financing that allows you to obtain a loan from another individual called an investor. By borrowing money in this way, you avoid using a financial institution, such as a bank or credit union. In other words, peer-to-peer (P2P) lending can be considered as “banking without the banks.”
P2P lending, also called crowdlending or social lending, provides specific amounts of money that are repaid over a defined term, and the lending party earns a return via interest payable on the loan. You can borrow this money as an individual or as a business. If you are a person looking to pay off your debt, you might be considering one of these unconventional loans to pay off credit cards or student loans.
How is P2P Different from Crowdfunding?
While P2P loans are the same as crowdlending, know that crowdfunding is different. Simply put, crowdfunding is the process of raising money from a group of people.
Crowdfunding is the overall term that includes various financial interactions including P2P lending.
Here is a list of crowdfunding:
- crowdlending or social lending or peer-to-peer lending
- equity crowdfunding
- rewards-based crowdfunding
- donation-based crowdfunding
- profit-sharing or revenue-sharing
- debt-securities crowdfunding
- hybrid models
How is it Different from Bank Lending?
You often see these loans available on various websites. Borrowers and lenders interact on these platforms where loans are available. Often, the P2P loan is at better terms than those normally offered by commercial banks or other financial institutions. However, money is usually provided at higher interest rates than those charged by banks.
Since peer-to-peer lending provides a higher rate of return for investors, conventional wisdom would suggest that borrowers have to pay more interest. But, that’s not how it generally works.
Think of it this way. Running a bank branch has its operational costs like:
- . A physical location has to be bought/rented and maintained.
- People are needed to run day-to-day banking operations.
- Salaries have to be paid and related benefits have to be offered to the staff.
- There are also equipment costs for items such as computers, printers, scanners, software systems, security tools, etc.
These costs are mostly avoided with P2P lending. This is why you have to pay double-digit interest on a loan, but can only earn around 1% (sometimes even less) return on the funds you keep as a deposit. It’s not the most proportionate financial arrangement, but that’s how the banking system works.
In contrast, peer-to-peer lending isn’t burdened by these operational costs. Since most of the interaction between borrowers and lenders is virtual, the terms are much more equitable. For instance, a 10% loan rate for borrowers that will enable investors to earn an 8% return on their money.
How Does P2P Lending Work?
Depending upon your credit-worthiness, peer-to-peer lending websites usually have a wide range of interest rates on offers. Different platforms set their own rates and other relevant conditions. An investor then opens an account with the service and deposits a predetermined sum of money.
The funds are now available for disbursement as loans. After that, you, as a borrower puts up your financial profile which is assigned to one of the available risk categories. This determines the interest rate(s) which you’ll have to pay. As a loan applicant, you can review different offers and choose the one that seems most suitable.
Many borrowers break the applications down into multiple parts and accept more than one offer as a result. All funds transfers and monthly payments are handled electronically through the P2P platform. However, some lenders and borrowers may choose to do so with less automation.
Popular Lending Platforms for P2P
Some websites may only serve particular kinds of borrowers, such as small businesses, patients dealing with a chronic illness, etc. But there are many popular lending platforms for P2P. The top ones include:
Prosper was among the very first crowdlending platforms to start operating in America. To date, it has provided loans in excess of $5 billion, while the number of active Prosper members stands at 2 million. The website offers personal loans ranging between $2,000 and $35,000.
Lending Club operates on a similar premise, though it’s not identical to Prosper. As the largest P2P lending service on the web, it has disbursed almost $16 billion in loans till now. The personal loan limit here is also $35,000, while interest rates normally range from 6.95% APR (Annual Percentage Rate) to 35.89% APR, depending on your credit grade.
Moreover, SoFi (short for “Social Finance”) specializes in student loans and refinancing. But, mortgages and personal loans are also available. In the same way, PeerStreet mostly caters to individuals looking for real estate loans, while StreetShares does the same for small businesses.
If you are working on paying down debt, you might be considering a P2P loan. You might get a better rate than your existing loans or your credit cards. Now you know more about P2P lending and can do your research to see if it makes sense for your situation. Just make sure you pay the loan down so you work toward a debt-free life.