The birth of the Internet changed just about everything, but one industry the Internet changed the most was finance. Investors no longer need the assistance of a professional to buy stocks, banking can be done on a smartphone, and traditional banks are no longer the only place to find a loan.
Lending is one area that has seen the most rapid evolution. When you needed a loan prior to the Internet, your options were limited to the traditional banks you could travel to or the lenders a car dealership or real estate agent had relationships with. These days, there are several options, with one of the most popular being peer-to-peer lending — individual borrowers seeking loans from willing individual lenders, who collect the installment payments as the return on their investment.
What Is Peer-to-Peer Lending?
Peer-to-peer lending, often referred to as P2P lending, is a relatively new lending service that connects lenders with borrowers. There are several popular platforms that facilitate P2P lending — more on those later.
Investing in peer-to-peer loans is relatively simple. If you’d like to go from investor to lender, follow these steps:
- Choose a P2P Lending Platform. There are several peer-to-peer lending platforms online today. However, you’ll want to work with one that has a history of solid service to both its borrowers and its lenders. The four most highly regarded P2P lending platforms online today are listed below.
- Sign Up and Deposit. Once you’ve decided which peer-to-peer lending site is best for you, all you’ll need to do is sign up and deposit funds to use toward providing loans. Keep in mind you’ll need to meet minimum investment requirements, which can be as low as $25 depending on the platform you use.
- Fund Loans. Finally, it’s time to start handing out loans. To do so, scroll through the requested loans in the P2P lending platform to decide which loans you’d like to fund. Once you’ve found loans that you’d like to back, choose and fund the loan on the platform.
Types of Loans Peer-to-Peer Lending Covers
The types of loans offered will vary depending on the lending platform you choose to work with. Some of the most common types of loans found through peer-to-peer lending networks include:
- Debt Consolidation Loans. Debt consolidation loans are used to pay off credit cards and other unsecured loans known for high interest rates. By consolidating these loans into a single peer-to-peer loan, the borrower benefits from reduced interest and a single monthly payment while the lender benefits from the returns provided through the interest paid on the loan.
- Student Loans. Peer-to-peer loans are often used as student loans, covering the cost of books, room and board, and college tuition.
- Small-Business Loans. Some peer-to-peer lending networks are geared toward providing loans to small businesses. Historically, small-business loans have been known for high interest rates, so small-business peer-to-peer loans generally provide higher returns to lenders than peer-to-peer loans provided to consumers.
- Unsecured Personal Loans. When seeking a personal loan for just about anything from buying a car to buying a new drone, or just having money in the bank, many consumers look to P2P lending sites. The reason is simple — consumers would often rather work with a peer rather than owing money to a traditional bank or credit union.
A Look Into the Borrowers
You wouldn’t — or at least shouldn’t — invest by giving a loan to just anybody. When deciding which loans to invest in, you need to know whether the borrower asking for the loan is going to pay you back.
When working with most peer-to-peer platforms, you have the option to choose who to fund and at what amount. To help you make an educated decision, most P2P lending services provide investors with the following information about the borrowers seeking loans on their platforms:
- Credit History. As a lender, you will generally be able to look into the credit history of prospective borrowers. If you find the borrower’s credit history to be risky, you can choose not to fund their loan.
- Employment Status. When giving a loan, it’s important that you have a reasonable expectation of getting your money back. You can’t reasonably expect to get repaid from someone who’s unemployed. As a result, most P2P lending platforms give you a glimpse into prospective borrowers’ employment status.
- Debt-to-Income Ratio. Even if the borrower has a good credit history and is a full-time worker, if they’re in over their heads in debt, your chances of getting your money back as an investor diminish. So, most peer-to-peer lending platforms provide the borrower’s debt-to-income ratio to their investors.
As an investor, what you’re ultimately looking for is someone who hits all three of these targets. The borrower should be employed, have a solid history of meeting their monthly obligations, and lack excessive debt.
Pros and Cons of Peer-to-Peer Lending
As with any other form of lending, peer-to-peer lending comes with its own list of advantages and disadvantages. Here are the pros and cons investors should consider before becoming a peer-to-peer lender.
P2P Pros for Lenders
Peer-to-peer lending can be a highly lucrative endeavor, with plenty of benefits for the investors-turned-lenders who take part in the process. Some of the most compelling perks associated with peer-to-peer lending include:
- Higher Returns. P2P lending returns range from 7% to 11% on average. Although these returns are in line with the historical average overall stock market returns, they are much higher than the average returns from bonds and other fixed-income investments. Because these investments provide a fixed monthly payment, they are far more appealing than traditional fixed-income securities to some investors.
- Helping Your Fellow Man. When you provide a loan through a P2P lending platform, you’re providing a loan to your peer — a real person whose goal you can often see along with their application. In providing funding for a borrower, you’re helping members of your community. So there’s a feel-good effect associated with peer-to-peer lending.
- Going Against the Grain. Some people don’t like banks or the traditional financial ecosystem as it operates today. Investing in peer-to-peer loans rather than traditional stocks, bonds, and CDs, means that you’ll be going against the grain and can feel like sticking it to the big banks. Many find solace or satisfaction in that.
P2P Cons for Lenders
Peer-to-peer lending is an exciting endeavor for the investors who take part in the process. However, there are a few disadvantages that you should consider before risking your first dollar on a P2P loan.
- No Prepayment Penalty. When making a fixed-income investment in the traditional sense, you know what the return of your investment will be over time. When you invest in a P2P loan, your return will be based on how the money is paid back. In general, there is no prepayment penalty involved, so if a borrower chooses to pay off your loan early, you’ll have to find another source of those valuable long-term returns.
- No Insurance or Government Protection. Currently there is no insurance available for peer-to-peer lenders. Moreover, government protection is nonexistent, as the P2P lending industry is highly unregulated. Without regulation, investors who fund P2P loans are accepting added risk in doing so.
- Liquidity Risks. When you fund a loan through a peer-to-peer lending platform, you’re accepting the fact that you won’t get your money back until the borrower pays it back. Although some P2P lending platforms allow for the sale of the loan to other investors, you’ll have to accept a reduced return, or even a loss, if you have an immediate need to access the money you’ve loaned out.
- Default Risks. As an P2P investor, you’re not investing in assets like stocks, bonds, or any other investment vehicle of tangible value. Instead, you’re investing in your fellow man or woman. However, if your peer decides not to pay you back, you’re out of luck. You may never recuperate your principal investment if a P2P borrower defaults on their loan.
Popular Peer-to-Peer Lending Platforms
P2P lending offers an exciting investment opportunity and a compelling way for borrowers to get the money they need. However, if you’re going to become a P2P lender, you’ll want to do so with a reputable lending platform. Some of the most popular on the market today include:
- Lending Club. Founded in 2006, Lending Club is one of the pioneers of the peer-to-peer lending industry. As such, the company offers both personal and small-business loans. Personal loans are capped at $40,000 and small-business loans are capped at $500,000.
- Prosper. Founded in 2005, Prosper is yet another pioneer in the peer-to-peer lending industry. However, the company only offers personal loans. Although some people use the funding from these personal loans as small-business loans, this is not advised because different types of loans come with different costs, structures, and ramifications should things go wrong. As with Lending Club, Prosper personal loans are capped at $40,000.
- Funding Circle. Founded in 2010, Funding Circle was one of the first peer-to-peer lending platforms geared specifically toward those seeking small-business loans and lenders looking to fund them. Funding Circle offers small-business loans with values ranging from $25,000 to $500,000.
- Upstart. Founded in 2012, Upstart also has a strong history of exceptional services. Like Prosper, Upstart only offers personal loans. However, with a cap of $50,000, they offer some of the largest personal loans found in the peer-to-peer lending industry.
Peer-to-peer lending may be relatively new, but it’s quickly becoming overwhelmingly popular. As a result, the marketplace is making loans available to consumers and small businesses while creating a compelling investment opportunity for those interested in supporting their peers.
Although an investment in a P2P loan can be a profitable endeavor, it will also come with significant risks that should be considered. Nonetheless, the vast majority of borrowers do pay their lenders back, and taking advantage of P2P investing opportunities may provide the perfect balance within a well-diversified investing portfolio.