Peer-to-Peer Lending

Peer-to-peer lending is a type of lending where one person borrows money directly from another, rather than borrowing from a bank or other financial institution. Peer-to-peer lending is also known as P2P lending, person-to-person lending, “social lending,” “debt-based crowdfunding,” or “crowdlending.”¹

Essentially, P2P lending is lending money to businesses and individuals online through platforms that connect borrowers with lenders.

What is Peer-to-Peer Lending?

A peer-to-peer loan is when an individual borrows money directly from another individual. This is often done through online peer-to-peer platforms that facilitate the operation by incorporating features that help the lender evaluate prospective borrowers.

Lenders can screen potential borrowers after assessing their credit history and the conditions of the loan they require. The minimum credit score set by these lenders is generally in the mid-600 range.² P2P lenders act as investors who decide to put money into many different loans to constitute a “portfolio” of loans that generate earnings through periodic interest payments.

Peer-to-peer loans have become a popular alternative for individuals and businesses seeking online funding. P2P personal loans can be used for many different purposes, including financing small expenses, paying for a new car, or even paying college tuition.

Comparing Peer-to-Peer Lending vs. Traditional Loans

P2P loans provide emergency funding similarly to traditional bank loans but operate differently. 

Borrowing from a bank or online lender is generally straightforward. If you apply and get approved, you can receive your money quickly. But, to get a P2P loan, you must create an account through a P2P platform and wait for a lender to bid on your loan listing. The amount of time it takes to get bids can vary, and there is no guarantee that you will get any bids. 

Rates on P2P loans can be lower than traditional loans since there are various lenders available and you can choose the best bid among many. In contrast, traditional loan rates are based solely on your creditworthiness and cannot be negotiated. 

The best loan option for you depends on various factors, such as your desired loan amount and how soon you need the money. When considering your financing options, you must weigh the pros and cons before committing to a financial agreement. 

Average Peer-to-Peer Loan Terms

If you are considering applying for P2P personal loans, it’s important to know the average loan terms you can expect to get. 

Disclaimer: Please note that these are general figures and can vary depending on the lender, your credit score, and other factors.

How Does P2P Lending Work?

There are two perspectives of peer-to-peer lending: the investor’s perspective and the borrower’s perspective.

How Does P2P Lending Work for Investors?

Investors who engage in peer-to-peer lending become active lenders in the platform they pick. They can usually choose from many prospective borrowers looking for funding. They are responsible for assessing the borrower’s creditworthiness, their reputation on the platform, and their overall financial situation to pick the proposals that fit the investor’s preferences.

If the investor is risk-averse, he or she will probably pick borrowers with a solid credit history, a high credit score, and a good track record of positive experiences on the platform. On the other hand, if the lender is inclined to invest in riskier opportunities, they may reduce the strictness of their criteria. The returns obtained on riskier loans are commonly higher than those on more conservative ones, as a higher rate applies to candidates who are perceived as riskier.

The main risk for those who invest in P2P loans is potential default. 

How Do Peer-to-Peer Loans Work for Borrowers?

Individuals and businesses can easily borrow money through P2P loan platforms by creating an account online and applying for the loan they intend to obtain. 

They must provide certain information required by the system, including:

• Their personal information, including their Social Security Number (SSN)
• Their credit information, including credit scores
• Employment information
• Other relevant financial information

Benefits and Risks of Peer-to-Peer Lending

The benefits of peer-to-peer lending vary for both investors and borrowers. These are some of the most relevant advantages. 

Benefits of P2P Loans for Borrowers

• Low-interest rates — With interest rates usually starting at 4% for individuals with a good credit score, peer-to-peer loans are less expensive than other alternatives and, in some cases, even less expensive than the alternatives offered by traditional lenders.
• Easy application process — Since P2P platforms operate 100% online, the application process is usually very straightforward, as it mainly requires that the borrower supply basic personal and financial information to start participating in the platform.
• Credit scores are not as important — Most traditional lenders require credit scores above 660 for borrowers to be eligible for a personal loan. In this sense, peer-to-peer loans are usually more flexible, as some lenders might be interested in extending loans to individuals with lower credit scores due to the higher interest rates charged on these loans.

Benefits of P2P Loans for Investors

• Portfolio diversification — High net-worth individuals and institutions may use P2P platforms as an alternative investment to traditional financial instruments, such as stocks, bonds, or commodities. Considering that these instruments behave in a unique way, they can provide a positive degree of diversification for investment portfolios.
• Good returns on investment — The average return earned by P2P loan investors is estimated at 5% to 9% per year.³ Even though the risks involved in lending must be considered, the returns vary depending on the degree of risk associated with the borrower’s credit profile and financial situation.

Benefits for Borrowers with Bad Credit

Peer-to-peer lending provides a lot of benefits for bad credit borrowers. While you may get automatically denied for a traditional loan, you could get multiple loan offers through a P2P lending platform. This allows you to choose a fair rate and repayment schedule for your financial situation. P2P lending is also regulated by the Consumer Financial Protection Bureau (CFPB), which ensures that lenders provide transparent terms and adhere to fair lending practices. 

Risks of Peer-to-Peer Lending

While P2P loans offer several benefits, there are risks you should consider. If you have bad credit, you may not get any bids on your loan listing, or you may only get bids with high rates and fees. Extensive credit checks are not typically done on borrowers, which means it’s possible a borrower could default or scam the lender. And unlike traditional loans, P2P loans are not insured by the Federal Deposit Insurance Corporation (FDIC). This means that lenders could risk losing their investment if the borrower defaults. 

What is the Cost of Borrowing Through P2P Lending?

The cost of borrowing a P2P loan includes the interest rate associated with the loan, along with other loan fees and expenses. Some of the most common fees applied to peer-to-peer loans are:

• Origination Fees — Origination fees are flat percentages collected on the nominal value of the loan. An origination fee is usually deducted from the amount transferred to the borrower. The origination fee can also be added to the outstanding loan balance.
• Prepayment Penalties — If the borrower wishes to pay for the partial or total amount of the outstanding balance of the debt before it is due, the P2P lending platform may charge a penalty. This penalty is waived by some platforms.
• Late Payment Fees — The platform may charge a late payment fee if the borrower fails to make installments on time.
• Servicing Fee — This is a fee often charged to investors, not borrowers, and it is usually paid monthly or annually for using the platform’s services. It can be a fixed fee or a percentage fee based on the average funds invested.

The cost of borrowing a peer-to-peer loan is usually expressed through what’s known as the annual percentage rate (APR), which is a calculation of the annual cost of borrowing the loan considering other fees, commissions, and expenses, along with the applicable interest rate.

The cost of borrowing a peer-to-peer loan varies depending on the borrower’s credit profile and financial situation. Most P2P lending platforms require that borrowers have a credit score higher than 600 to be considered eligible, and they must also reside in a state where the lending platform is authorized to operate.

Tips for Borrowers with Bad Credit

Borrowing money with bad credit is challenging, but you can find the best loan offer for your situation by researching lending platforms and avoiding loan terms that could worsen your finances. While extended repayment terms are convenient, they cost more overall and can increase your existing debt. 

The best way to achieve success with P2P lending, or any financing option, is by working on improving your credit score. Borrowers can boost credit by reducing existing debt and avoiding late payments. 

Frequently Asked Questions About Peer-to-Peer Lending

CreditNinja: The Bottom Line on Peer-to-Peer Lending Bad Credit

Peer-to-peer lending is an alternative option to traditional lenders. But, while the credit requirements can be flexible, the rates and fees can actually be higher. When rates and fees are high, they can increase financial stress for the borrower.

At CreditNinja, we offer quick personal installment loans with competitive interest rates, flexible payment schedules, and convenient repayment terms. Apply for online loans today and see why we have so many positive reviews online!

CreditNinja provides loans, but we want to stress the importance of having a good reason to borrow money. It’s critical to avoid taking out loans unless you have a financial emergency. Limiting the amount of outstanding debt you have can help you maintain good financial health!

References:

1. What is Peer-to-Peer (P2P) Lending? │ P2Pmarketdata
2. Investing in Peer-to-Peer Lending: Risks and Rewards │ YieldStreet
3. Red flags of peer-to-peer lending│Bankrate