Peer-to-peer lending has become a hot topic in the personal finance community. Offering up a way to access loans without working with traditional banks, this type of lending has become a popular option, especially among the millennial generation.
There are major benefits to borrowing from peer lenders rather than from traditional banks, one of the biggest being interest rates.
Without the overhead costs associated with operating a traditional bank, peer lenders have the ability to earn higher returns on their money while providing borrowers with lower interest rates than those offered by most banks.
There are other advantages too, especially for borrowers who have had trouble qualifying for the best rates on bank loans.
What Is Peer-to-Peer Lending?
Peer-to-peer (or P2P) lending is a relatively new lending service that connects lenders directly with borrowers. There are several popular platforms that facilitate this type of lending — more on those later.
P2P lending is relatively simple on the borrower’s side. Applying for a loan on a peer-to-peer platform is similar to applying for a loan with a traditional bank and can be done entirely online.
When filling out your application, you’ll need to provide:
- Identifying Information. This includes information like your name, phone number, address, birth date, and Social Security number. When working with a respected lending platform, your personal information is kept safe with the platform; your peer lender or group of peer lenders will never have access to this information.
- Income. As with any other lender, P2P lenders want to make sure they’ll be able to recuperate the cost of the loan plus interest. For this to happen, you’ll need to demonstrate you have enough income to repay the loan. So your income and income source will be requested.
- Credit Authorization. As with traditional financial institutions, peer lending sites require a credit check before providing a loan. Below-average credit may result in your request for a loan being denied.
- Loan Amount. You need to tell the lender the loan amount you’re requesting.
- Reason for Loan. Finally, some lending platforms require borrowers to explain what they plan on using the funds for. Although P2P loans are unsecured loans, these platforms often display the reason for the loans to their networks of lenders, some of whom may be more likely to give a loan to a student for college books than to a person who wants a new motorcycle.
Types of Loans Offered
You can get a loan from a peer for just about any reason, but the most common types of these loans include:
- Personal Loans. Personal loans are provided for any reason. Maybe you need cash to cover a vet bill, or you want to go on a vacation. Regardless of your reason for a personal loan, looking to peers may be the way to go.
- Debt Consolidation Loans. Debt consolidation loans typically come with lower interest rates than credit cards and other unsecured loans. If you’re looking for a way to reduce your overall interest burden while consolidating your accounts into one easy-to-manage monthly payment, this is a strong option to consider.
- Small-Business Loans. Small-business loans are hard to come by and often come with incredibly high costs. Thanks to websites that connect peers in need of money with peers that have money, this is no longer the case. Many peer lenders are happy to help support a promising small business.
- Student Loans. Many consumers look to websites that connect peer lenders with peer borrowers as a way to get the money they need for textbooks and other expenses associated with a college education.
How to Qualify for a Peer-to-Peer Loan
The qualification criteria for a P2P loan are similar to those for a loan from a traditional bank. The most important eligibility criteria to consider before applying include:
As with any other loan, your FICO score will play a major role not only in your ability to qualify for a loan but also in your interest rate if you’re approved.
After all, lenders on these platforms are not covered by FDIC insurance, meaning if you don’t pay back the loan, they lose their investment.
- Poor Credit: Borrowers with poor credit scores may not qualify for a loan through a peer platform at all. If this is the case, you may want to consider looking into your credit report and addressing any issues as well as applying for a secured credit card to boost your credit score.
- Fair Credit: Some P2P lenders require borrowers to have good credit or better, while others will allow borrowers with fair credit history to see if they can get their loans funded in the network. However, if you have a fair credit score and you are approved for a P2P loan, there’s a strong chance your interest rate will be high.
- Good Credit: Those with a good credit history will generally qualify for peer-to-peer loans regardless of the platform they apply to. In most cases, borrowers with a good credit history will enjoy lower interest rates than those charged by traditional banks or credit unions.
- Excellent Credit: Finally, if you have an excellent credit history, you have the best chances of qualifying for a low-interest P2P loan. Borrowers with excellent credit are the least risky investment for lenders on these platforms.
Most peer-to-peer lending websites require borrowers to have one of the following employment statuses:
- Employed Full Time: As a full-time employee, you work an average 40-hour workweek and consistently earn a paycheck.
- Self-Employed: Self-employed individuals are accepted for most loans through these platforms as well. However, be prepared to verify your income — embellishing your income will result in your loan being declined, even if you would have qualified otherwise.
- Retired: Retired individuals who receive a regular retirement income can also qualify for peer-to-peer loans, so long as they have the required credit history and the income they receive is enough to cover the cost of the loan considering other household expenses.
Borrowers who are unemployed will generally not qualify for a loan regardless of their credit score.
Finally, your debt-to-income ratio will play a major role in your ability to qualify for a loan, be it peer-to-peer or otherwise.
Your debt-to-income ratio compares your total recurring monthly debt to the amount of income you generate on a monthly basis. If your debt is too high in relation to your income, chances are you’ll have a hard time getting a loan, regardless of the type of loan you’re seeking.
In general, a good debt-to-income ratio is 36%, with no more than 28% of your monthly income allocated to your monthly mortgage, rent, or other housing expenses.
Although these P2P platforms are generally more lenient than traditional banks, credit unions, and other lending companies, if your debt-to-income ratio is higher than the benchmarks listed above, you may want to work on paying off debt or finding a source of extra income before applying for a loan.
Pros and Cons of Peer-to-Peer Lending
Borrowing from your peers comes with its own list of pros and cons. Before borrowing money through any lending platform, borrowers should consider the following:
There are several benefits associated with borrowing from your peers as an alternative to borrowing from traditional banks and other financial institutions. Some of the most significant perks include:
- Lower Interest Rates. Because P2P lenders don’t have the overhead associated with traditional banks, interest rates tend to be lower with peer-to-peer lending than with traditional lending. This is especially true for borrowers with excellent credit scores.
- More Relaxed Requirements. Even if you don’t qualify for a loan through a traditional bank, you may still qualify for a loan with a peer-to-peer lender.
- Lower Minimum Payments. Because P2P loans come with lower interest rates and often longer loan terms, minimum payments on P2P loans are generally lower than on loans provided through traditional lenders.
- No Prepayment Penalty. In the vast majority of cases, there is no prepayment penalty attached to peer-to-peer loans. So, if you have the money to pay your debt off early, you can make early payments to save on interest without being penalized.
Although peer-to-peer loans offer plenty of perks to borrowers, every rose has its thorns. Here are a few drawbacks to consider before applying for a P2P loan.
- Lower Loan Amounts. A peer is more likely to give a $100 loan than a $1,000 loan, and $10,000 loans or $100,000 loans can be harder still to come by. This is because the average peer lender simply doesn’t have the financial capacity a traditional bank or credit union does. If you’re looking for a large loan amount, peer-to-peer lending might not be the way to go.
- Origination Fees. In some cases, peer-to-peer websites charge an origination fee for any loan funded through their platform. So, although the loan may come with a lower interest rate than those charged by traditional banks, origination fees can cut into those savings.
Top P2P Lending Platforms
There are several platforms that connect borrowers and peer lenders. Some of the most popular include:
- Lending Club. Founded in 2006, Lending Club is one of the pioneers among platforms that connect consumers in need of loans with peer investors. It’s one of the largest, most trusted P2P lending platforms on the market today. The company tends to be the best for borrowers with a low debt-to-income ratio, those who have co-borrowers, and those looking for small-business loans.
- Prosper. Founded in 2005, Prosper is another pioneer in the peer-to-peer sector. Like Lending Club, Prosper has grown to become one of the largest, most well-respected P2P lending platforms online today. In particular, the platform is best for those with high credit scores or consumers with high debt-to-income ratios.
- Upstart. Founded in 2012, Upstart has become the premier platform for startup businesses that need a bit of cash to fund their opportunities. When compared to traditional banks, the business loans offered come with lower fees and interest. Moreover, the fact that you’ll be working with peers rather than big banks is appealing to many small-business owners.
There are several ways to go about getting a loan. However, as technology advances, more options are being brought to the table, allowing everyday people to easily fund loans to their peers while earning a return on their investment.
As with any lender, not all peer-to-peer loans are created equal. It’s important to compare offers on different platforms before deciding to accept any loan.
When comparing, look out for origination fees and compare the costs of these fees against higher-interest options that may have the potential to yield a lower overall cost.