Peer-to-Peer Lending 101

Joseph Meyer
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The complete guide on peer-to-peer lending:

P2P lending is an innovative financial concept that is still a bit mysterious to many people. Basically, it’s a market where private individuals and small businesses can lend their hard earned money to other private individuals and small businesses, and earn money for it.

Peer-to-peer lending has made a significant name for itself over the past decade. Numerous loan groups have grown over the years, and more than a few investors have been quite happy with the returns they’ve received.

When you want to get started with lending, there are several factors that you’ll need to keep in mind.

This article will cover everything you should know about P2P loans … from the very basics to the more complex subjects.

Table of Contents

  • Introducing Peer-to-Peer Lending
  • How It Works
  • What are the risks and what should I consider?
  • How can I get started?
  • The nitty gritty details

What is peer-to-peer lending?

Peer-to-peer lending (P2P lending) is a term used to describe borrowing or lending money through an online platform. As opposed to visiting a traditional bank, with a P2P loan, users deal exclusively with other people who are typically unknown to them via the Internet. The responsibility of vetting these people, and setting interest rates, lies with the online lending platform.

One of the biggest benefits of peer-to-peer lending is the relatively low interest rates. The average interest rates you’ll find on P2P marketplace websites are in the range of 5.0-8.0%, regardless of your credit score. Interest rates range based on three main factors: borrower, loan, and lender.

Outside of interest rates, fees are also typically lower for peer-to-peer loans compared to traditional banks. The average P2P lending platform charges a fee of 3-5% for processing the loan, which is significantly smaller than the average 15% charge that traditional banks charge.

Peer-to-peer lending is ideal for people who need short-term loans. Most P2P platforms limit loans to a term of three to five years. If someone has a lower income, doesn’t have traditional credit, but needs money for a three-year loan, this option could be great.

Lending sites in the U.S.

Several peer-to-peer lending platforms have cropped up in the US in the past few years. I’ve used Lending Club exclusively to make small personal loans (although I’ve backed several startups on Kickstarter), but there are several other sites that are worth checking out.

Lending Club: largest P2P lending platform

When you’re thinking about investing, you have two general options: buy-and-hold or freelance investing. Both of these have their advantages, and many people dabble in both. Part of the appeal of P2P lending is that you can “test-drive” it without risking a substantial amount of money.

If you’re new to peer-to-peer lending, or if you’re just looking for a refresher, here’s a quick rundown of how it works.

On more than one occasion, I’ve heard the analogy that P2P lending is like a singles bar: it’s infinitely better to find a single good loan and keep it beyond its term than to constantly rotate loans that you don’t know well.

SoFi: student loans and refinances

As a borrower, you can take the money you need from a group of professional investors and experts, instead of a bank. Sofi connects with the global market of investors, giving you access to better rates and terms than a bank could, and allowing people to personalize and build their own portfolios.

Prosper: first P2P lending platform

In many ways, stocks and bonds are outdated. Now you have the option to invest in peer-to-peer lending. Peer-to-peer, or P2P, lending is a modern way to make business loans to individual borrowers. Lenders can share in the risk and the reward.

Prosper is the original peer-to-peer lending site. Its investors come from Australia, the United States, and the United Kingdom.

So, how does Prosper work? Geektyrant offers an enlightening description of how peer-to-peer lending works.

[[1]]The online platform helps to match people who need loans with those who have money to lend. After answering a few questions about how much they want to invest, how long they want to invest over, and interest rate they want to charge, borrowers are matched with peer-to-peer investors who are willing to loan them money.

[[2]]The investors can read borrower profiles and see their credit scores. The investor decides which borrower to lend to.

[[3]]Once the transaction has been made, the money is dispersed to the borrower.

[[4]]The borrower repays the money with interest, either through payments or a lump sum. Peer-to-peer lenders can cash out or reinvest their funds.

PeerStreet: real estate loans

PeerStreet is a company that uses the concept of a cryptographic blockchain to help put the power of investing in real estate back into everyday people’s hands. It’s the perfect option for people looking for a way to diversify their portfolios while gaining access to normally inaccessible opportunities, and doing so with far less risk than they would get from stocks and bonds.

PeerStreet works by matching investors with real estate assets throughout the country. The process is simple – investors check out the available options, and if they see one that they like, they can snap it up through an online transaction. The process is essentially identical to how other platforms work – with a few blockchain-specific nuances.

PeerStreet differentiates itself from its competitors by building its entire platform on the blockchain. Its decentralized approach to real estate investing safeguards money while maintaining a strict level of transparency. In the past, a banking institution would act as an intermediary between investors and lenders. From the perspective of lenders, this could be expensive and time-consuming.

Fundrise: property investment

We’ll dive into the details of Fundrise investing in Chapter 14. Fundrise is a peer-to-peer (P2P) investing platform. P2P platforms match up investors with small to mid-sized real estate projects with promising potential for returns. You do not need to work from a remote location or bring on contractors to renovate a property like you do with other real estate investments.

Three ways to invest on Fundrise:

{1}. Lending. Fundrise’s Lending product is an investment that operates like an online, peer-to-peer personal loan. Borrowers can use your money for a wide variety of purposes, including real estate development. Investors can expect a maximum 11% annual return with FOLIOfn lending.
{2}. Crowdfunding. Investing in small to mid-sized real estate projects is the hallmark feature of the Crowdfunding product. You invest in these projects through the use of “Crowdfunding Certificates,” which can be traded on secondary exchanges. Crowdfunding investing, like the lending program, enables you to earmark your funds for a wide variety of real estate purposes.

Funding Circle: business loans

Upstart: the non-traditional newcomer

When people think about peer-to-peer (or P2P) lending, they usually think of a few big names: Lending Club, Prosper, and of course, Upstart. But Upstart is a bit different from these companies.

Upstart is a new kind of lending platform, one that uses innovative data-driven research methods to assess its borrowers’ creditworthiness – and gives investors a new way to diversify their portfolios.

Borrowers on Upstart apply for either a six-year or a three-year loan, and commit to using the funding in any way they choose – a new business, retirement, home renovation, wedding, you name it. If Upstart approves a borrower, it pairs them with investors who themselves have agreed to fund a loan.

What does this mean for borrowers and investors? It means that, unlike other P2P lending platforms, Upstart is approving people that many traditional banks might refuse to lend to – people who have average or below average FICO scores, who don’t have traditional credit card debt or a mortgage. And it means that investors who might not otherwise be able to tap into the P2P investment space can diversify their portfolios. It’s a win-win situation.

PeerForm: individual and small business loans

Available to everyone.

I was sitting on the couch a couple of months ago, listening to the radio, doing my usual mindless radio surfing. My mind channel switched over to the Bloomberg channel, and a segment came on discussing various peer-to-peer lending options and the advantages of each.

Having had very little experience with peer-to-peer lending prior to that moment, I was immediately intrigued.

What is peer-to-peer lending?

Peer-to-peer lending is the concept of lending money to people who want to borrow money. The borrower identifies an interest rate that compares favorably against the higher rates that typically accompany standard credit lines, and you get to decide whether you want to lend the money. In short, it’s like getting to be a part-owner of a loan for a real person.

Why would anyone invest through a P2P platform?

Expecting to make a return on your investment is a good reason to invest through a peer-to-peer lending platform. The truth is that P2P lending is no different than any other investment. Returns on investment depend on the quality of the investment because you can either make money from loans you make or lose money from loans that you participate in. Although the quality of the loans in some P2P lending platforms may not be the best, the interest rates that you receive on the loans vary on your credit standing or the risk you are willing to take. But, the riskier the loan, the higher the risk of a loss and the higher the interest rate on the loan.

There are also investment platforms wherein you can invest in more than one loan at the same time. Some platforms also allow you to select loans so you can pick loans you want to invest and get rid of the loans that you don’t want to invest in.

Finally, investing through a P2P lending platform can also be a way to diversify your investment portfolio.

Why would a borrower use P2P?

Even though borrowing money from a bank can be easier, safer, and quicker, there are many situations when it’s just not an option. For example, let’s say you need cash to launch your new business but a bank won’t give you a loan. This is where you’ll need some other options.

People who are looking to borrow money, just like people who are looking to lend money, choose to use P2P lending platforms because they appeal to certain advantages.

For example, P2P lending platforms give you the flexibility to choose exactly the terms you want for your loan, assuming that the borrower is seeking a personal loan.

Also, since you can simultaneously search for loans and lend money on P2P lending platforms, you can use them to increase your passive income stream.

However, one of the biggest advantages of P2P lending is the lack of an intermediary. This means that you’re directly interacting with the borrower and that you can maintain a direct line of communication with the borrower. This can make the process much faster and simpler.

How it works

Peer-to-peer lending (P2PL) is one of the simplest ways to take advantage of your idle money. P2PL companies help match borrowers with lenders for very low-interest loans. The most popular P2PL companies are Prosper and Lending Club. By choosing to lend through peer-to-peer lending companies, you can invest in the economy in a low-risk manner, and at the same time, lend to an individual in need of your loan.

Sign up with a P2P Lending Company

Both Lending Club and Prosper work in the same way. Once you sign up, they will review your application and determine how likely you will be able to repay the loan. After you are approved, you can deposit that money into your account with the P2P company. You can then browse through the available loans to see which loans you want to borrow money for.

Browse through the loans

There are many different types of loans on both of these websites. In fact, it can be quite difficult to choose which loans you want to invest in when you first start out. P2PL lends to borrowers from all backgrounds and at different levels of credit. You will find investors who want to borrow money for new restaurants, equipment, and real estate, as well as investors who want to pay off credit card debt, personal loans, mortgage debt, or student loans.

Loan application steps

When you are beginning your peer-to-peer lending journey, you need to carefully evaluate the candidates who have applied for your money. If you are approaching a P2P platform with a defined investment strategy in mind, you should be able to filter the loan applications based on your strategy and set your interest rate.

● Due Diligence

You should check loan application details, the borrower’s profile, credit score, loan purpose and repayment behavior (if available) when identifying candidates to lend to.

● Looking at Different Lending Opportunities

Once you’ve completed the first review process, you can check out various investment opportunities available on the platform that will be in line with your investment strategy. You can even build a pipeline of loans before choosing the ones to fund.

● Choosing the Right Loans

You can use different investment strategies to pick the right loan to fund. For example, you can evaluate loans based on profitability and risk-adjusted return.

● Managing Your Lending Portfolio

Once a loan is funded, you will need to keep an eye on the portfolio. You need to ensure the borrower pays you back as scheduled, make sure the borrower doesn’t have any challenges paying you back, and decide if and when you want to sell the MOUs. This process is called monitoring and managing the realized loan.

Loan Characteristics

Loan P2P brings borrowers and lenders together to form a new financial ecosystem. When a borrower asks for a loan online, they can provide a list of their shopping needs to gain potential lenders. The lenders can bid and decide which loan they are willing to fund. When the lenders find the loan interest rates quoted attractive, they can fund the loan before the deadline.

Depending on the regulations and competition from the traditional banks, the interest rates offered by the P2P loan companies may vary. Lenders are typically put into groups of 20 to 100 investors. Each lender owns a part of the loan and receives interest between 1% and 12% per year.

The interest rates are determined by the amount of risk the lenders consider in you. If you have a long time employment history and a good payment history, lenders may be willing to give you a higher loan amount. On the other hand, if you are unemployed or recent in your credit history, a lender may be more reluctant to loan you money.

Types of peer-to-peer loans

{1}. Personal loans
{2}. Business loans

The most common peer-to-peer needs are business loans. So let’s start there.

Common loan types available include:

There are many different types of peer-to-peer loans available for borrowers. If you’re new to this space and are looking for loans, it’s a good idea to take a look at what’s available so that you can get an idea of how you’d like to borrow.

Investing Software Services

Is the act of lending money to another person on an Internet forum or over the phone safe and reliable? For many people, they are wary to lend or borrow to strangers because this type of loan does not have the same security and guarantees as your bank. Fortunately, peer-to-peer lending platforms are here to streamline and simplify the process, helping to protect you and your money. Let’s take a closer look at the peer-to-peer lending process.

About the Author

Vijay Sanghvi is the founder and CEO of Lending Club, the world's largest peer-to-peer lending marketplace. Prior to founding Lending Club, he was a partner in J.P. Morgan's global corporate actions team managing the bank’s securitization activities. Previously, he was an Associate Professor at the University of California, Santa Barbara, where he helped develop a graduate course on non-profit management at the school's prestigious MBA program.

He has an MBA from the Wharton School of Business and a Ph.D. in Economics from the University of Pennsylvania.

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