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What Is Peer-to-Peer Lending?

Understanding P2P Lending

The history of Peer-to-Peer (P2P) Lending

Special Beacons

Peer-to-Peer Lending Q&As

Personal Loans, Loans

What Is Peer-to-Peer (P2P) Lending? Definition and How It Works

By Julia Kagan

Updated December 20, 2022

Reviewed by Thomas J. Catalano

Fact checked by Amanda Bellucco-Chatham

What is Peer-to-Peer (P2P) Lending?

Peer-to-peer (P2P) lending allows individuals to obtain loans directly from other people eliminating institutions as the middleman. Websites that facilitate P2P lending have greatly grown in popularity as a different method of financing.

P2P lending can also be referred to by the name of “social lending” or “crowd lending.” It has been in existence since, but the crowd of competitors already comprises Prosper, Lending Club, Upstart, and StreetShares.

Important Takeaways

Peer-to peer (P2P) loan is one form of technology for financial transactions that allows individuals to lend or borrow cash from another without having to go through a bank.

P2P lending sites connect borrowers directly to investors. The site sets the rates and conditions and facilitates the transactions.

P2P lenders are individual investors who are looking to earn more money from their savings in cash that they would receive from a savings account at a bank or a certificate of deposit.

P2P lenders are seeking an alternative to traditional banks, or the possibility of a lower interest.

The default rates for P2P loans are much higher than the default rates for traditional finance.

Understanding Peer-to-Peer Lending

P2P loan websites link borrowers to lenders. Each site sets rates and terms, and facilitates the transaction. The majority of websites offer a broad variety of interest rates based on the creditworthiness of the person who is applying.

An investor creates an account with the website and deposits a sum of funds to be distributed in loans. The loan applicant posts an financial profile which is assigned a risk category that decides on the interest rate the loan applicant has to pay. The loan applicant has the option of reviewing offers and decide to accept one. (Some applicants break up their requests into pieces and take multiple offers.) The money transfer and the monthly payments are handled through the platform. The process can be entirely automated, while lenders and customers can decide to haggle.

Certain websites specialize in specific types of borrowers. StreetShares, for instance, is specifically designed for small businesses.1 Additionally, Lending Club has a “Patient Solutions” category that connects physicians who provide financing programs to prospective patients.2

The history of Peer-to-Peer (P2P) Lending

In the beginning the P2P loan system was viewed as offering credit to those who would be spurned by traditional institutions, or as the ability to consolidate student loan debt at lower interest rates.

In recent times, however, P2P lending sites have increased their coverage. They are now targeting consumers who want to pay off credit card debt at low interest rates. The home improvement loans and auto financing is also available at P2P lending sites.

The rates for applicants with good credit tend to be lower than comparable bank rates, whereas rates for applicants with sketchy credit scores could be higher. LendingTree.com is an example. It provided personal loan rates of 5.99% to 35.99 percent as of Dec. 15 2022.3 Peerform posted loan rates at a range of 5.99 percent up to 29.99%.4 The average interest rate for credit cards was 19.59 percent as of Dec. 14th, 2022, according to CreditCards.com.5

To lenders, P2P loans are a method to earn interest on their cash at a rate higher than those offered by conventional bank savings or certificate of deposit (CDs).

Certain P2P sites let lenders begin with a balance of as little as $25.

Special Beacons

Individuals who want to lend money using P2P lending sites must be aware of the possibility that their borrowers will default on their loans the same way that traditional banks are prone to do. Studies on P2P lending platforms has indicated that defaults are far more frequent than the defaults faced by banks that are traditional, often in excess of 10%.6

In contrast, the Index of the S&P/Experian Composite index for defaults across all types of lending for U.S. borrowers has fallen from about 1.55 percent to 0.59% over the ten years before November of 2022.7

Any consumer or investor looking at a P2P lending website must also look into the fees on transactions. Every site makes money differently, but fees and commissions could be charged to the lender, the borrower or both. Similar to banks, sites can charge loan origination fees, late fees, and bounced-payment charges.

Is peer-to-peer lending (P2P) safe?

Peer-to-peer lending can be more risky than a savings account or the certificate of deposit however the interest rates are often significantly higher. This is because people investing in peer to peer lending website assume the majority of the risk. This is usually taken on by banks and different financial institutions.

How big is Peer-to-Peer (P2P) loans?

The market for peer-to peer lending was valued at $83.79 billion as of 2021 according to data from Precedence Research. This number is projected to be $705.81 billion by 2030.8

How can you make an investment in peer-to peer lending?

The most straightforward method to invest in peer-to-peer lending is to make an account on a P2P lending site and begin lending money to borrowers. These sites typically let the lender choose the characteristics of their borrowers and allow them to choose between high risk/high returns and less risky returns. Alternatively there are many P2P lending sites are publicly traded businesses, which means that one can also invest in them by purchasing their stock.

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