Peer-To-Peer Lending Basics (2024)

For many years, you had to visit your local bank if you wanted to borrow money and see if the institution was willing to approve you for a loan. But that approach didn’t work well for everyone, and banks turned many people down for financing.

Today, there are many different ways to borrow money. And some financing options don’t involve working with a traditional lender at all.

Peer-to-peer (P2P) lending cuts out the middleman and lets borrowers get loans directly from individuals. This form of social lending aims to make financing and investing more accessible—and it’s a model that has worked well for millions of borrowers and investors. Some experts predict that the P2P lending market will grow by around 30% in the next five years.

What Is Peer-to-peer Lending?

Peer-to-peer (P2P) lending represents an alternative way for borrowers to access financing. The idea of P2P lending is to give borrowers access to funding through individual investors rather than traditional financial institutions or online lenders. In turn, the investors themselves are the ones who collect the interest fees a borrower would normally pay to a bank or other lender.

By cutting out the middleman, the P2P setup gives investors a chance to receive a bigger return on their investment. At the same time, however, those investors take on the risk of loaning money to a consumer or business and not getting repaid as promised.

How Peer-to-peer Lending Works

Peer-to-peer lending companies use technology to manage both the borrowing and investing sides of the process. However, the steps vary depending on whether you’re seeking a loan or hoping to make an investment that will bring you a positive return.

How to Borrow Money

From the borrower’s perspective, peer-to-peer lending looks a lot like applying for a personal loan or some other type of financing. Here’s how the process works.

1. The application. The financial technology (fintech) platform you choose will likely direct you to fill out an information form or application. On the form, you should expect the platform to ask you for details such as your name, address, Social Security number (SSN), date of birth and other personal information.
2. Risk assessment. Next, the fintech platform will assess your risk as a borrower, often using artificial intelligence (AI) to analyze your information. Your credit report, credit score, job history, education, income and other details may all be considered to determine whether to approve your application and what terms to offer if you do qualify.
3. Matching with an investor. If a peer-to-peer lending platform determines that you’re eligible for financing, it may present you with several loan options from different investors. You can go through the offers, review the terms and conditions, and decide if one of the loans looks like a good fit for your situation.

Keep in mind that you may have to pay extra fees to the peer-to-peer lending platform itself. These fees may be in addition to the interest rates and fees the lender itself charges.

How to Lend Money

Peer-to-peer lending companies use an online platform to manage the investing side of the business as well. As a would-be investor, here’s how the process may work from your perspective.

1. Determine eligibility. You may need to satisfy certain eligibility requirements to be able to invest money through a P2P lending platform. For example, you might need to live in a certain state or meet a minimum net worth and income threshold to participate. Some P2P lending institutions may only accept accredited investors as defined by the Securities and Exchange Commission (SEC).
2. Create and fund your account. If you qualify to invest with a peer-to-peer lending platform, your next step is to create an account. From there, you can deposit funds with the lender so that you’re ready to review applications from potential borrowers.
3. Choose where to invest. Every platform is different, but most P2P companies will allow you to review the risk profiles and funding requests of different applicants. You may be able to choose to fund some or all of a borrower’s requested loan amount according to the investment funds you have available and your comfort level where risk is concerned. Some investors prefer a less hands-on approach. If you fall into this category, you may be able to set up automated investing protocols depending on which P2P platform you use.
4. Monitor your earnings. Once you have distributed your investment to different borrowers through the P2P platform, you can monitor your returns. As borrowers repay their loans, you will receive reimbursem*nt for the funds you loaned out plus interest earnings. And, of course, any investor fees that the P2P company charges you will likely come right off the top.At the same time, late payments or defaults could offset any returns you earn, and perhaps even result in a loss. For this reason, many P2P investors will opt to diversify their loan portfolios in an effort to build in some protection against potential defaults and losses.

Pros and Cons of Peer-to-peer Lending

As a borrower, it’s important to enter into any financing agreement with your eyes wide open and a clear understanding of the lender’s terms. Below are some benefits and drawbacks you may want to consider where peer-to-peer lending is concerned.

Pros of Peer-to-peer Lending

• More lenient approval criteria: Every P2P platform is different. However, you can generally expect P2P loan approval criteria to be more lenient than you might encounter with a traditional financial institution. As a result, it might be easier to get a P2P loan than other types of financing, especially if you have bad credit.
• User-friendly application process: P2P lending uses fintech to connect potential borrowers with investors and fund loans for eligible applicants. The loan application side of the P2P transaction is typically online, fast and easy to navigate.
• Prequalification: P2P platforms often offer borrowers the chance to see if they can prequalify for funding. Prequalification typically involves a soft credit inquiry that will not hurt your credit score along with a sneak peek at the interest rates and fees a P2P lender may offer you if you’re eligible for a loan.

Cons of Peer-to-peer Lending

• Fees: Interest rates on peer-to-peer loans can sometimes be competitive compared with other funding options. But there are other costs, like origination fees and more, that might offset or even overshadow the potential savings.
• Better rates are not guaranteed: There’s no guarantee that you’ll receive a lower interest rate through a peer-to-peer lending platform than you would with an online lender or elsewhere. In fact, your P2P loan interest rate might be higher than another lender would offer you.

Alternatives to Peer-to-peer Lending

Peer-to-peer lending can be an innovative way to borrow money, especially for those who struggle to qualify for traditional loans. Nonetheless, it’s not a perfect borrowing option for everyone. Consider these alternatives if you need to access funding but don’t believe peer-to-peer lending is the right fit.

Personal Loans

Whether you need to borrow money for unexpected expenses, home improvement projects, debt consolidation or something else, a personal loan might provide a useful source of financing. Well-qualified borrowers with good credit are likely to find the best deals. However, bad credit personal loans might still be an option depending on your circ*mstances.

Credit Cards

Credit cards can be great financial tools to help you establish credit history, earn rewards and enjoy robust fraud protections that debit cards and cash don’t offer. However, the average credit card interest rate is high, and they tend to be an expensive way to finance purchases over the long term.

There are, however, a few situations when borrowing money with a credit card could make sense. For example, an introductory rate credit card offer with a low or 0% APR might be an affordable short-term financing solution.

Home Equity Line of Credit

Homeowners have another potential borrowing option to consider when they need financing—home equity lines of credit. A home equity line of credit, or HELOC, is a revolving financing tool that combines the flexibility of a credit card with a (typically) lower interest rate.

Depending on the lender you may need good but not perfect credit to qualify for a HELOC. And since you’re securing the loan with the equity in your home, interest rates can be more affordable. On the flip side, there’s a big risk associated with HELOCs. If you are unable to repay the money you borrow as promised in the future, there’s a chance you could lose your home to foreclosure.

Bottom Line

If you think a peer-to-peer loan looks like it might work well for your borrowing needs, it’s crucial to take your time and shop around. Compare multiple lending platforms and pay close attention to the interest rates and fees each company charges.

A P2P loan is just as big of a commitment as a personal loan or other form of financing. So, you don’t want to rush the research phase and wind up applying for a loan that you could regret taking down the road.