Peer-to-Peer Lending: What It Is and How It Works for Borrowers and Investors
In this digital age, more borrowers contemplate where to borrow money online. While mainstream banks and other traditional financial institutions are not easy to take out loans from, more people are looking at other options to borrow money online. Peer-to-peer (P2P) lending, also known as crowdlending and marketplace lending, is an option getting popular these days.
Since its inception in 2005, peer-to-peer lending has witnessed exponential growth, especially in the United States, the UK, and China. These three countries have turned out to be the major peer-to-peer lending markets.
What is Peer-to-Peer Lending?
According to a New York-based financial source, peer-to-peer (P2P) lending allows individuals to obtain loans directly from other individuals by eliminating the involvement of any financial institution as a middleman. Many P2P lending websites and apps now offer alternative lending options to those looking to borrow or invest money.
Be it a personal loan, real estate loan, or business loan, peer-to-peer lending makes it easier since one can use an app for borrowing money online.
How Peer-to-Peer Lending Started?
Peer-to-Peer lending started in 2005 in the United Kingdom. It picked up pace in 2008 when due to the recession most banks accepted loan applications only from those who had the perfect credit score. Fortunately, peer-to-peer microlending filled the gap for those with bad credit who couldn’t secure loans from banks.
How Peer-to-Peer Lending Works?
P2P lending or crowdlending brings borrowers and lenders together. Through lending and borrowing money apps, borrowers can easily borrow money and lenders can lend money online.
To better understand how peer-to-peer lending works, you need to understand how it works for both parties involved.
How Peer-to-Peer Lending Works for Borrowers
If you are looking for ways to borrow money online, but your credit score doesn’t work in your favor, peer-to-peer lending is the way to go.
Here’s how most lending and borrowing money apps work:
- You start by answering a series of short questions.
- Once done, a soft credit check is triggered.
- Your credit score determines your loan grade.
- Your loan grade is then evaluated and reviewed by investors.
- This review determines if one or more investors are willing to lend money to you.
- When the above criteria are met, your loan application gets approved.
- You’ll need to provide some important documents, such as employment proof, income proof, and current debts (if any).
- Your documents are then compared with your initial questionnaire. Based on this comparison, your money-borrowing process can proceed in two ways:
– Your loan application gets approved, or
– The investors ask for additional documentation.
- When your loan application is approved, you get the final loan documents. Once you sign these documents and return them, the approved loan amount gets wired to your account within the next 24 to 48 hours.
All these steps occur digitally, so, the loan application process becomes streamlined and efficient. You simply need to use an app for borrowing money and use your email to send scanned documents.
Peer-to-peer lending is generally used for loans ranging from $2,000 to $35,000. However, you can also use this method for loans bigger than the said amount. Bigger loans will require you to have a fair credit score, which should be at least 600.
Duration of Peer-to-Peer Loans
The average loan term of peer-to-peer loans varies from three to five years. Having said that, the microlending platform you choose and the type of loan you take can extend or shorten the loan term.
Processing Fee for Peer-to-Peer Loans
Most of the peer-to-peer money lending companies have an origination fee that ranges from one percent to 5 percent of the approved loan amount. This fee also varies on the following factors:
- Your credit history
- Loan term
- The reason for taking out a loan
- Loan amount
- Your income
The origination fee gets deducted from your loan before the amount is transferred to your account.
How Peer-to-Peer Lending Works for Investors
Investors are required to invest a minimum loan amount, and they can choose to invest beyond that minimum amount for each loan. You can diversify your investment by microlending money to different people to minimize your risk. Some borrowers will keep paying you back and your investment won’t take a major hit.
Since each lender invests in a certain proportion for a particular loan, the return will also be proportional. Investors receive their principal amount and the interest in full.
Pros and Cons of Peer-to-Peer Lending for Investors
If you are looking to diversify your portfolio beyond conventional investment methods and get good returns, peer-to-peer lending is a great way to go. There have been numerous instances where investors have seen a return as high as 18%. No wonder many investors have opted to go for peer-to-peer lending.
This lending approach is also good for investors who are willing to take some risks. The key pros of peer-to-peer lending are:
- You can quickly and easily open your investment account.
- Almost every website and app for lending money allows you to invest as little as $25.
- You get to choose from thousands of potential borrowers.
- You have all the required information for these borrowers at your disposal.
- The huge number of borrowers allows you to diversify your portfolio.
- You get monthly returns on your investments (ROIs).
On the flip side, there are some cons to peer-to-peer lending too:
- While the good returns may lure you to take huge risks, you may also take a hit if borrowers default.
- Peer-to-peer diversification experts suggest you should diversify your investments among at least 175 different loans. These numbers add up to a huge amount if you invest a substantial amount.
- With the huge diversification of your portfolio, you’ll also need more time and effort to manage them.
- You can’t sell the investment until the loan period is complete.
Pros and Cons of Peer-to-Peer Lending for Borrowers
There are many reasons why this particular lending method is better than traditional loans:
- Bad credit doesn’t create a hurdle for borrowers to get a loan.
- Depending on your credit score, the interest rate may be way less than that of a conventional bank.
- In comparison to credit card interest rates, the interest rate of P2P lending is substantially low.
- Being a digital method, the loan application process is fast and streamlined.
- The interest rates are fixed.
- The operational fee is less than banks.
- P2P loans are unsecured loans, so you don’t need to worry about collateral.
The cons of P2P lending are not exclusive to this particular lending method, but they may cause some trouble for you when you don’t pay off the loan. You can end up owing more debt, and in case your credit score is bad, the interest rates may be higher than you’d expect.
Whether you are an investor or a borrower, peer-to-peer lending is a great method of putting money in circulation. It can be a win-win situation as long as both parties involved commit to their roles.
Visit Lendee.com today to learn more about how you can borrow or invest money through the platform.