How Does Peer to Peer Lending Work
Need a personal loan?
Fifteen years ago, your options would have been limited to applying formally for a personal loan to a bank or other lending institution or perhaps quietly asking your wealthy cousin Frankie if he could spot you the money for a few months. Now, though, you have an option somewhere between those two extremes.
Peer-to-peer (or P2P) lending allows you to borrow from other individuals rather than institutions but with some of the controls and formalities of traditional lending. It allows you to deal with individuals rather than institutions without having to jeopardize your personal relationships by borrowing money from friends.
Is this a good option for you? That depends on the details and how they apply to your situation.
Peer-to-peer personal loans: how they work
Peer-to-peer lending, crowdfunding, or social lending, has grown into a business that makes tens of billions of loans every year. This form of lending is largely a function of Internet technology: it matches up people needing personal loans with investors looking to earn a return by making loans.
The sites typically use technology to quantify the risk of each would-be borrower. Interest rates are determined according to the borrower’s risk level, and then loans are made out of pools of money provided by investors. Those investors can set parameters for what risk and return characteristics are acceptable to them.
Effectively, peer-to-peer lending investing technology allows individual investors to come together to play the risk-assessment and lending role traditionally played by banks and other institutions.
P2P lending investing: risks and benefits
Is having peer-to-peer lending take the place of traditional lending a good idea? There are pros and cons to it for both borrowers and investors.
From a borrower’s standpoint, P2P lending gives them another potential source for a personal loan. More choices increase a borrower’s opportunities to find a better rate. Also, this non-traditional approach to lending may give borrowers with damaged credit a chance at getting a loan that a traditional lender wouldn’t make.
On the downside for borrowers, this new source of funding may come at a price. Annual percentage rates on some crowdfunding sites range as high as 35.99% for lower-rated borrowers, a level that makes it wiser not to borrow money.
As for the other side of social lending, investing by making loans can provide an opportunity to earn substantial interest rates at a time when rates on income investments are generally quite low. The best P2P lending sites for investors have platforms that are designed to reduce risk by using various formulas to assess borrower creditworthiness and by spreading your investment out among multiple borrowers.
Investors should keep in mind that borrowers turning to social lending rather than institutional lenders may be doing so because their credit would not meet traditional underwriting standards. Also, because the popularity of crowdfunding is a relatively recent phenomenon, the likelihood of default has not been widely tested through a recession.
Peer-to-peer lending reviews
The following descriptions of some prominent peer-to-peer lending sites can give you a feel for how personal loans are made through social lending:
- LendingClub. A pioneer in the field of social lending, Lending Club offers a variety of loan types as well as a variety of account types on the investor side. APRs currently range from 5.98 percent to 35.89 percent for three or five-year loans, with loans available in amounts up to $40,000.
- LendingKarma. This platform is really a hybrid between informal loans between individuals who know each other and a full peer-to-peer lending platform that packages loans and finds investors for them. LendingKarma is for lenders and borrowers who already know each other and have worked out loan terms. At that point, LendingKarma plays the role of administering the loan, providing legal documents, interest and principal calculations, and repayment schedules and tracking.
- Peerform. Peerform provides a range of loan options to you based on your qualifications once you have filled out a brief background form. The loan option you choose is listed for investors alongside your risk characteristics to see if investors will choose to fund it. Peerform makes three and five-year loans from $4,000 to $25,000, with rates currently ranging from 5.99 percent to 29.99 percent.
- Prosper. Along with a platform that emphasizes speed, Prosper offers a wider range of loans than many peer-to-peer lenders, with things like auto and home improvement loans alongside personal loans. Loan amounts vary from $2,000 to $40,000 for three or five-year loans, and rates currently range from 6.95 percent to 35.99 percent.
- Upstart. Upstart looks to improve beyond traditional lending criteria such as credit score by assessing your future earning potential based on your education and occupation. Upstart offers three and five-year loans in amounts ranging from $1,000 to $50,000, and rates currently range from 9.57 percent to 29.99 percent.
If you are looking to borrow money, these platforms give you another option to consider alongside traditional lenders to find the best personal loan terms. If you are looking to invest, just be aware that while crowdfunding can offer higher returns than other income vehicles, that means it also is likely to entail higher risk.
