Peer-to-Peer Lending 101
Written by: Kristy Welsh
Last Updated: October 5, 2017
Are you in the market for a personal loan but having trouble qualifying through a traditional bank? Are you an investor looking for an alternative to traditional investments? If so, it’s worth looking into peer-to-peer-lending. Find out what it is, how it works, and whether it’s right for you.
What is Peer-to-Peer Lending?
Peer-to-peer lending is pretty much what it sounds like — individuals (investors) lending money to individuals (borrowers). There is no brick-and-mortar bank involved. Instead, the middleman is an online platform that matches investors with borrowers. The same platform services the loans, too.
Peer-to-peer lending is also known as person-to-person lending or P2P.
What Are the Peer-to-Peer Lending Platforms?
Lending Club finances both personal and business loans. Prosper only finances personal loans, but you can use the money for business expenses.
What Can Borrowers Finance Through Peer-to-Peer Lending?
You can finance pretty much anything. For instance, Prosper’s drop-down menu of loan purposes includes debt consolidation, home improvement, medical/dental, business [expenses], large purchase, household expenses, auto/motorcycle/RV/boat, taxes, baby & adoption, other. (They also list special occasion and vacation, but those aren’t purposes for which we recommend taking on debt; save up for those instead.)
How Much Can Borrowers Finance Through Peer-to-Peer Lending?
It depends on the platform. For instance, Prosper offers personal loans from $2,000 to $35,000. Lending Club offers personal loans from $1,000 to $40,000 and business loans from $5,000 to $300,000.
What Fees Are Involved With a Peer-to-Peer Loan?
Both Lending Club and Prosper charge borrowers interest fees and origination fees that vary depending on credit rating and length of the loan.
How Long Do I Have to Pay Back a Peer-to-Peer Loan?
Loan terms for personal loans through Lending Club and Prosper are 3 or 5 years. Loan terms for business loans through Lending Club are 1 to 5 years.
What Are the Benefits of Peer-to-Peer Lending?
Benefits for Borrowers
- Application and approval process is fast and easy – apply online, receive an answer within minutes, and receive funding (if qualified) within days.
- May be easier to get approved for a loan than through the traditional banking systems.
- If the platform reports payment history to the credit bureaus, borrower is able to build good credit.
- The same consumer protection laws apply as through traditional banking systems.
Benefits for Lenders
- Lenders can choose the loans they want to finance.
- A lender is able to earn interest higher than what can be earned through other types of traditional investments, like savings accounts and CDs.
- Risk-adjusted returns, as investors can spread their investment over a number of different loans.
What Are the Drawbacks of Peer-to-Peer Lending?
Since peer-to-peer loans can be easier to get than traditional loans, borrowers may be tempted to take on debt they don’t really need or can’t afford. Borrowers will also be charged a loan origination fee as high as 5 percent.
What’s the Difference Between Peer-to-Peer Lending and Crowdfunding?
Peer-to-lending is a loan that must be paid back in its entirety, plus interest. Crowdfunding is donations that do not need to be paid back. That said, crowdfunding may require recipients to provide something to donors/investors in return for donations, like shares of their business or rewards/prizes.
How Do Borrowers Qualify For Peer-to-Peer Loans?
Specifics depend on the platform but, in general, a number of factors determine eligibility, including credit score, income, and debt-to-income ratio.
What if a Borrower Defaults on Their Peer-to-Peer Loan?
As with traditional loans, peer-to-peer loans in default enter into the collection process, which is handled by the lending platform (e.g., Lending Club, Prosper).