A Peer to Peer lending (P2P) is a kind of open borrowing of money to businesses or individuals. It has no financial institution’s interference acting as an intermediary in the transaction. An online platform commonly executes this lending that connects lenders with potential borrowers. After the transaction period and the creditor repaid the loan, the lender will get the money back with interest. However, a peer to peer money lending can be riskier than a savings account. Peer-to-Peer lending provides both secured loans and unsecured loans. But, the majority of peer-to-peer loans are personal loans that come with risks.
The peer to peer lending is also known as Crowdlending” or “social lending.” It was founded in 2005 but has earned tons of competitors. Familiar companies are StreetShares, Upstart, Peerform, LendingClub, and Prosper
What Is Peer To Peer Lending?
How Does Peer-To-Peer Lending Work?
P2P lending is a simple process that requires all the transactions executed via a specialized online platform.
The Single Steps How The P2P Lending Process Works
- The potential borrower interested in getting a loan will, first of all, fill out an application on the P2P online lending platform.
- The platform will then assess the application, and then the platform will deter the applicant’s credit rating and risk. After the assessment, the platform allocates the applicant to the proper interest rate.
- When the applicant’s application is approved, he or she will receive from the investors the available option based on his/her allocated interest rates and credit rating.
- The applicant can then examine the recommended options and select one of them.
- The interest payments are then made by the applicant, usually every 30 days, and at maturity, the principal amount’s repayment.
Both the investors and borrowers are charged a fee for the company’s services in charge of the online platform.
Is P2P Lending Safe Without Any Risk?
Just like your typical business, there will always be a form of risk here and there. So is the same with P2P. It is not entirely safe. It has its risks. Peer-to-peer lending is risky for various reasons, and it is essential to recognize these risks and how they can be handled or reduced.
1. The Risk Of Default
The business or individual you lend your money might not be able to pay it back. This process is ‘defaulting.’ On the peer-to-peer website, the more the default rate, the higher the number of businesses or people unable to pay back their loans. Unlike some financial institutions like banks, no Financial Services Compensation Scheme will secure the money you lend through a peer-to-peer site. Some peer-to-peer websites have provision funds or contingencies made to pay back a lender just if the borrower defaults. The term and conditions of these contingencies or provision funds vary from one P2P website to the other. So, ensure you understand what it entails if you are thinking of becoming a lender.
2. The Risk Of Early Or Late Repayment
There is also a risk if the creditor repays your loan early or late. You might not make much profit as expected. Though if the creditor pays your loan before, you can lend it out again, but there is a likelihood that you might not be eligible to lend the money out at the same interest rate.
3. The Risk Of The Peer To Peer Site Going Out Of Business
If the peer-to-peer company goes out of business, you could lose all your money. If the P2P is overseen by the Financial Conduct Authority, just as P2P in the UK, then the lender’s money must be kept in a separate account.
So, before you lend through a peer-to-peer lender, make sure you check that the Financial Conduct Authority regulates it. You can do this by searching for it on the Financial Conduct Authority (FCA) Register.
Advantages Of Peer-To-Peer Lending
P2P lending offers some vital advantages to both the lenders and borrowers:
- Higher Returns To The Investors
Peer-to-peer lending usually gives investors higher returns relative to other types of investments.
- Accessible Source Fund.
For some borrowers, P2P lending is a source of funds that is more accessible than other conventional loans from financial institutions. This process may be due to the credit rating of the borrower or the purpose of the loan.
- Lower Interest Rates
Because of the competition between the lower origination fees and the lenders, the P2P loan interest rate is usually low.
Disadvantages Of Peer-To-Peer Lending.
- Credit Risk
P2P loans are susceptible to high credit risks. The majority of Borrowers who apply for peer-to-peer loans have low credit ratings that don’t enable them to procure a bank loan. Hence, a lender should be conscious of the default likelihood of his/her counterparty.
- No Government/Insurance Protection.
The government doesn’t offer insurance or any protection to the lenders in case the borrower default.
- Legislation
Some jurisdictions don’t allow P2P lending or instruct the companies that offer such services to acknowledge investment regulations. Therefore, P2P lending may not be available to some lenders or borrowers.
Can I Make Money With Peer To Peer Lending?
As the lender, you can make money from peer-to-peer lending through the interest rate. The borrower has to pay a certain amount of money as interest, which counts as profit for the lender. Online platforms that run peer-to-peer lending also make money from service charges levied on the lender and borrower.
For What Can I Use A Peer-To-Peer Loan?
Many P2P loan platforms offer unsecured personal loans. This circumstance means that you can use the funds almost any way you want. But most lending platforms inquire that you state the loan’s purpose. The significant reasons for securing a loan are medical expenses, home improvement, and other important purchases. The sites also note that you can’t use the loan funds for higher education costs, investments, gambling, or other illegal purposes.
The Bottom Line
While you are contemplating on whether taking a loan from a P2P lender is the right step for you, make sure you can answer these questions:
- Will I be able to pay it back?
- Is there any other place I can get a better loan interest rate?
- How long will it take for me to be able to pay back the loan?
