A Guide to P2P Lending
What is P2P Lending?
Peer-to-peer, or P2P, lending has created a financial revolution over the last several years by eliminating the middleman in loan transactions. With P2P lending, you can take loans directly from other people or businesses.
Both the borrower and the lender benefit from peer-to-peer loans. The benefit to the people making the loan is that they create steady income via interest payments. This interest often exceeds that which can be earned via traditional means like CDs, saving accounts and money market funds.
However, P2P lending is not without its drawbacks. The lenders rely on a complex matrix of approval criteria to determine risk, and there is the possibility that the new risk models may not be as accurate as believed.
On the borrower’s side, to compensate lenders for the risk of lending money, the quantity of interest charged for peer-to-peer loans may be higher than traditional prime loans. Here are eight things to keep in mind with P2P lending.
Your guide to peer-to-peer lending
- Peer-to-peer loans match investors and borrowers.
With peer-to-peer lending, borrowers don’t submit an application to a bank or other financial institution. Instead, they create a profile on a website, and that acts as their application. Investors then review the online profiles, and if they like what they see, they offer a loan to the applicants.
- Borrowers have a choice of loans.
Borrowers are not required to take out any of the loans which they are offered. Rather, they can review the terms and interest rates created by various investors, and they can determine which one they prefer. If they don’t see a loan that works for them, they don’t have to take one out. In the P2P lending world, this is referred to as the auction process.
- Credit scores and debt-to-income ratio are factors.
If you decide to apply for a peer-to-peer loan, the P2P platform creates a profile for you which includes information about your credit score and debt-to-income ratio. Every P2P lender does this slightly differently. For example, some lenders may show applicants’ credit scores, while others may assign ratings such as A, B or C to borrowers. Don’t worry: Although profiles are public so that investors can see them, they don’t contain your real name, ensuring your privacy and security.
- However, P2P lending can also look beyond credit scores.
However, while credit scores can play a big role, the application process looks past them. While creating your profile, you also get to explain why you need a loan, and this part of the application can be critical to attracting a lender or investor. For example, an investor who sees an enticing application may be more likely to loan to that applicant than to another applicant who doesn’t have a clearly defined purpose for the loan, regardless of whether or not the second applicant has a better credit rating.
- Peer-to-peer lending does not leverage data like many online lenders.
Although peer-to-peer lending uses technology to connect borrowers and lenders, it does not leverage data in the same way that fintech lenders do. The data varies based on the type of loan the applicant applies for, but it may include stats from sites such as eBay, Amazon, PayPal and countless others. In addition, these companies can also collect data from the applicant’s QuickBooks software. All of this data creates a much more accurate picture of the borrower than a simple profile on a P2P site does.
- The application process is longer than some loans, shorter than others.
Applying for a peer-to-peer loan is arguably faster than applying for a business loan through a bank, especially because borrowers don’t have to create lengthy business plans. However, P2P applications take longer than applying for loans from online lenders, and they can take longer than applying for a credit card online, as well.
- Approval and funding times can vary.
With many online lenders and even with online credit card applications, a decision can be rendered in just a matter of seconds, and for online loans, in particular, funding can happen the same day or the next business day. With peer-to-peer loans, approval and funding times vary. Because borrowers have to wait until an investor becomes interested in their profiles, the process can take anywhere from a few minutes to a few days to a few weeks.
- Investors receive better rates but less security.
Investors who want to put their funds into peer-to-peer platforms have the opportunity to earn interest, and in almost all cases, the nominal rate of return exceeds that of savings accounts, money market accounts and Treasury Bonds. However, if you lend money over a P2P site, your investment is not guaranteed as it is with these other investment vehicles.
Now that you understand basic information about peer-to-peer loans, let’s take a closer look at what you need to know to get one.
How to get a P2P loan
- It’s important to realize that a peer-to-peer or social loan is a real loan.
Some borrowers wrongly assume that since the loan is not from a bank or other traditional lending company, it is not an actual loan. Therefore, one can default without penalty.
However, nothing could be further from the truth. Legally, a P2P loan is the same as a bank loan. Not to mention that the primary peer-to-peer lending sites are highly regulated by the SEC, as well as at the state level.
- Be ready for a unique approval process when applying for a peer-to-peer loan.
The peer-to-peer lending platform will request an application which is either approved or denied based on the lending criteria of the particular platform. If your peer-to-peer loan is approved, the loan request is placed on the platform for investors to fund the loan.
- Make certain that peer-to-peer lending is available in your state.
Lenders are regulated at both the state and federal level. Although additional states have legalized peer-to-peer lending, not every state allows every platform.
- Be aware of the fees.
As you know, loans have more costs than just the interest rate. Many borrowers have been fooled by a very low-interest rate combined with high loan fees. Don’t fall into this trap. Fees for peer-to-peer loans are often high to support the platform’s development and infrastructure.
Of course, the worse your credit rating with the lender, the higher the fee charged by peer-to-peer lender platforms. Fortunately, you do not need to pay the fee out of your own pocket; it’s deducted from the loan amount.
Peer-to-peer or social lending is a good alternative for some borrowers, but it’s critical to keep in mind that these loans have the same legal ramifications as any other loan. Next, there is a unique approval process that takes into account hundreds of data points, unlike traditional lenders. Finally, be aware of the fees which can be quite high from peer-to-peer lenders.