Peer to Peer Lending
What is Peer to Peer (P2P) Lending?
Peer to Peer Lending (commonly abbreviated as P2P Lending) is a type of lending that involves cutting out the middleman in a lending transaction. Who is the middleman? Typically a bank or a credit union. When you borrow money from a bank, the bank has to have cash to fund that loan. They get that cash from the deposits of their customers (customers are called “members” at credit unions). Banks charge a higher rate for the money they lend out than they pay on their deposits. This is for three reasons: 1) they have overhead costs, 2) some loans will default and won’t pay back (this is referred to as credit risk), and 3) they are in business to make money. With Peer to Peer lending, the middleman is removed from the equation. People interested in borrowing funds are matched with people interested in making money by lending money out; in other words, they are “investors”.
Why is Peer to Peer Lending Advantageous to Me?
As a borrower, you will be able to get better rates than you would by borrowing from a bank or a credit union, because the middleman is removed from the equation. The peer lending companies charge a small fee to match the borrowers with the investors. This fee (paid by the borrower) is minuscule compared to the savings the borrower recognizes by having access to a much a lower interest rate.
As an investor, peer lending provides individuals with an opportunity to diversify from other investment types like the stock market. Historical returns for the typical peer investor significantly exceed the average rate on certificates of deposit (CDs) at banks or credit unions (CDs are referred to as “share certificates” at credit unions).
As an Investor, Is My Investment at Risk?
Technically yes, but practically, no. Investors receive monthly payments of principal and interest as the borrowers make their payments. When you invest in loans with the peer lending companies, you don’t invest in a single loan, or even a handful of loans. Instead, you invest in dozens, if not hundreds of loans, giving the investor significant diversification. Furthermore, payments are automatically withdrawn from the borrowers’ bank accounts, so borrowers won’t simply forget to pay, or have checks lost in the mail. Since loan payments are automatically deducted from the borrower’s bank accounts each month, you are assured that the peer lending company (and thus you the investor) are at the top of list of creditor claims. The peer-to-peer lending companies provide statistics of what their borrowers earn on average. As an investor, it is up to you to select how much risk you want to take, by selecting how your portfolio of loans is broken down in terms of credit quality, etc.
How Much Money Can I Borrow?
That’s difficult to answer, because it depends on a number of factors, including your creditworthiness. However, most of the peer lenders offer loans that range from a few thousand dollars to tens of thousands of dollars. You will need to check the individual companies’ websites for the specifics of that company.
How Long is the Payback Period?
Again, this depends on several factors. Most of the peer-to-peer lending companies allow loans from approximately two to five years. You will need to check the individual companies’ websites for the specifics though.
What Kind of an Interest Rate Can I Get
This is highly dependent on your current credit score (plus a host of additional other factors). Suffice it to say though, that your rate will almost assuredly be lower than the unsecured (aka “signature”) loan rate that you could get at a financial institution. Furthermore, it will typically be much lower than the rate on a credit card.
What Can I Use the Loan Proceeds For?
While there are some restrictions, you can use the proceeds for most of the things you would typically use loan proceeds for. For example, you could purchase an engagement ring, renovate your house, take a vacation, buy a car, pay off student loans, pay off credit cards, consolidate debt, etc. Since peer-to-peer loans are considered “unsecured”, there is no need to sign over collateral to anyone (e.g. you do not need to sign your car title over to anyone).