What Is Peer to Peer (Person to Person) Lending?

There has been a lot said about peer to peer (P2P) lending lately. With the economy and credit market crunch making it difficult to get more traditional loans, “alternative” lending opportunities are arising.  Peer to peer lending is a way for those who might be turned down by a bank to get the loans that they want/need, while providing an opportunity for investors to make some money by lending to others.

What is P2P (Person to Person) Lending?


Basically, P2P lending is when an ordinary person loans money to another ordinary person using an intermediary.  Rather than go through an institution, like a bank, a loan can be had through a P2P lending site where investors can pool together resources to fund a borrower’s loan proposal.  Right now, two of the most popular P2P lending sites are Lending Club (Review)and Prosper (Review).  These sites help connect people who want to borrow money to those who have a little extra money to lend.

For borrowers, the process gets underway after filling out some information.  Borrowers have their credit checked, and they state how much money they want, and why they want it.  Borrowers can get money for a number of purposes, from debt consolidation to business start-up to car purchase.  Some even use P2P lending to pay for school.  Lenders can then decide how much they want to lend to the borrower.  Once the the loan is fully funded, the money is disbursed to the borrower, and he or she starts making payments on a schedule.  Most loans are three-year loans, but some P2P lenders are beginning to introduce five-year loans.

As one might expect, there are fees that need to be paid, as well as interest charges.  As with more traditional loans, your credit score does make a difference in your interest rate.  One of the nice things about using a peer to peer lending site is that interest, fees and other expenses are figured and collected for you.  Additionally, borrowers only need to make payments to one place (the P2P site), the site makes through that payments plus interest are made to the lenders.

For lenders, it is fairly straightforward.  It is possible to lend money in $25 increments, choosing which borrowers they want to invest in.  If a lender wants the chance of a higher return, he or she can provide funds to someone with riskier credit.  Of course, this increases the chances that the lender may not be repaid; peer to peer lending represents risks to lenders, since the borrower can default.

Who Can Benefit from P2P Lending?

Peer to peer lending comes with different benefits for different people.  For borrowers, it is a way to get a loan that they might not be approved for otherwise.  Additionally, the interest rates charged are often comparable to — or lower than — what is offered by many more traditional institutions.  If credit cards are involved, peer to peer lending can provide a way to pay off debt without paying such high interest rates and reducing the effect of compounding.

For investors, P2P lending provides an opportunity to earn a return on money that can be higher than what the stock market or bonds have offered recently.  Even the lower interest rates offer reasonable returns.  It offers a chance for ordinary people to make money in a way that is similar to the way banks make money off of loans.  However, there are risks as well, since it is possible to lose money when a borrower stops paying on the loan.

P2P lending is worth looking into, since it provides opportunities for borrowers and investors alike.  Just make sure you understand what you are agreeing to before you sign up.

Recommended Peer to Peer Lending Sites: Lending Club | Prosper

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Published or updated March 28, 2013.

Comments

  1. I have been wondering how the lending club works for a while. Do you actually directly fund a persons loan? Does that mean you act like a loan officer and assess their cases and decide to invest?….. If so that’s kind of exciting investing!!!!

  2. FFB: Thanks for putting this article together. 3 common misconceptions are:
    1) person A borrows from person B: in reality, a loan is made by hundreds of people investing a minimum of $25 at a time.
    2) a way to get a loan if you can’t get it anywhere else: not at Lending Club, where the benefit is you typically get a lower rate based on a good credit history.
    3) it’s the same as microfinance: not quite. Here is a post where I explain the differences:
    http://blog.lendingclub.com/2010/10/22/microfinance-crowdfunding-and-peer-to-peer-lending-explained/

  3. I’ve been hearing more about this as well, including some personal stories from people I know in our city.
    P2P lending is definitely worth investigating further.

  4. Brett | Investing Part Time says:

    I think p2p lending is a great tool that has a lot of potential. Lending Club is great especially because they turn down something like 90% of loan apps on their site, so not everyone can simply apply for money and get it. Their repayment rate is quite good, so it makes sense for both parties: investor and borrower.

    I plan on checking this out in the coming months.

    • It is a good idea. It gives investors an option to stocks, bonds, and CD’s and allows borrowers an opportunity to get competitive rates without going through a bank or using credit.

  5. For those interested I actively invest and wrote a Lending Club review. I discuss all of the ins-out of investing in Lending Club.

  6. Robert Muir says:

    So far I’ve lost about 10% of my initial investment in LendingClub. Hopefully by the end of 3 years I’ll break even.

    If you would take it personally when an individual defaults on your investment in them after you’ve bought into their story, then I would recommend NOT investing in p2p. For me, I found that I do take it personally, so I’m going to divest myself of the investment.

  7. Another related system/idea that I participate in is micrloans – I currently am lending $25 to a Peruvian woman to help create a water purification system! It’s pretty cool!

  8. I used Prosper.com in the early days and was making out OK until the economy hit the skids. What stinks is they started pulling out of various states and now lending club isn’t allowed in several states either, so I can’t use P2P as an asset class. Just waiting around for it or another network to be approved here. Oh well.

  9. I also just read that the peer to peer lending has hit $1 billion. This is a great way to get loan as long as you can document your income. Self employed borrowers who show a loss will have a tough time getting qualified. I tried but my DTI was a little to high.

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