I love the concept of peer to peer loans and lending. Anything that reduces our reliance on the big banks, is definitely worth exploring further. So today I am going to go through the ins and outs of peer to peer loans and what it means for you as either a borrower or a investor / lender
What is Peer to Peer Lending?
Let’s start off with the basics. Peer to Peer or Person to Person lending (commonly abbreviated to P2P) is where two people (one a lender and one a borrower) lend each other money.
Now traditionally the role of lending agent is played by a bank, while the role of borrower is often played by a person looking to acquire money, in return for paying back interest on debt to the lender.
Peer to peer loans are essentially the same, but instead of the borrower going to the bank for money, they go to a P2P lending website where there are lots of “peers” (lenders / investors) ready to lend you money in-place of a bank.
What are the Benefits of Peer to Peer Loans?
The benefits of peer to peer lending are twofold, as it benefits both the lender and the borrower. Let’s start with the lender benefits first.
As a lender you have a few great benefits:
- Significantly higher return on investment than bank interest
- Diversification of investments
- Ability to choose your investment amount
- Ability to choose the interest rate a borrower will have to pay
- Ability to choose the amount of risk / reward by lending to only specific borrowers that meet your borrowing criteria
It’s not all about the lenders, borrowers can benefit too:
- Ability to get finance even with bad credit (some lenders are willing to take on a higher level of risk than the banks)
- Often a borrower can get a lower interest rate than a bank would offer
- Ability to borrow more money than a bank might offer
- Ability to consolidate debts into one easy to manage loan
The real advantage for both the lender and the borrower is that the bank is now out of the picture, so that means both the investor and the borrower can share in a greater amount of the benefits as the cost of doing business is much smaller.
Check out this video for more information (note it is based on Australia, but still relevant across all peer to peer lending)
What are the Risks to Peer to Peer Loans?
I know that so far peer to peer loans look like the best thing since sliced bread, but like all good things, there are risks associated with it. I will run through a few of the most common risks, but please do remember that my answers are not going to be specific to you, and a lot will be determined on what country you live in and what vendor you select as your P2P lending agent.
What if the borrower doesn’t pay up on time / borrower doesn’t want to pay?
If a borrower is late on a payment, then the loan is considered to be delinquent and there will be a bunch of fees that the borrower will be charged (again, this will depend on the P2P website you go through) based on a schedule of rates that would have been agreed to at the start of the loan. Note: With most websites I have seen, interest will continue to accrue on the loan even when the account is considered delinquent.
What if the borrower goes bankrupt?
Generally, when a borrower files for bankruptcy the P2P agency will go through the process of putting the account into a bankruptcy status and will stop loan payments from being collected. From there the P2P agency will file all the required paperwork to the bankruptcy court where the amount owed on the loan is filed on the bankruptcy petition. What happens next is up to the courts, but if the borrower has an income then often the borrower will be required to make payments though a bankruptcy trustee via a monthly plan that has been approved by the court.
Most of the P2P lenders will forward any recovered funds back to the lender, whilst the borrower will have a bankruptcy appear on their credit report.
Default / Bankruptcy Mitigation Plan: A few things you can do as a lender to mitigate the risk of borrower default:
- Review credit reports thoroughly before agreeing to lend to a borrower
- Choose clients with an excellent repayment history
- Do not distribute all your money into a single loan. Make lots of smaller loans, which has the effect of diversifying your investment across a number of borrowers. This way should one default, the rest should likely still be fine.
What if the P2P lending site goes bankrupt?
Most P2P companies have backup loan servicing plans in place should they file for bankruptcy. This means that a third party would end up servicing the loans for the lenders.
Best Peer to Peer Lenders
The USA peer to peer lending scene has two main players:
The main Australian peer to peer lending websites are:
The main UK peer to peer lending websites are:
Peer to Peer Borrowing
So you like the sound to all this peer to peer loan stuff and want to give it a try – great! Before you jump in you need to know that most P2P websites allow a maximum loan of about $30,000-$35,000.
Peer to Peer Student Loans
Student loans are almost the perfect fit for peer to peer lending. The reason I say that is because many students won’t have a lot of financial backing and so getting a loan can be difficult. By utilizing a peer to peer loan there shouldn’t be any issue getting the money needed.
Peer to Peer Personal Loans
Personal loans are another great reason to look into getting a peer to peer loan. Whether you want to buy a car, renovate your house, go on a holiday, invest in the stock market or start a business, peer to peer personal loans are going to be a great option if you want to try and get a better interest rate than the bank, or if you are worried the bank won’t give you credit.
Another really common reason for people to take out a peer to peer loan is because they want to consolidate all their existing debts into one. This can enable a person to get a better interest rate by merging their debts together and stop paying so much in interest each month. Ultimately this will enable a person to pay off their debt faster, provided the money saved thought the lower interest rate is put back into the loan as extra repayments.
Peer to Peer Mortgages
Because most P2P websites cap the amount you can borrow to about $30K, you will likely struggle to get a full mortgage for a house via a peer to peer loan. I suspect that once the market matures this will become available, but for now you may have to go to a traditional financial institution.
What if I have bad credit and want to borrow?
As I mentioned above, bad credit doesn’t necessarily mean that you won’t be able to get a peer to peer loan, it just means that you will likely have to pay a higher rate of interest. The reason for this is because the lenders won’t be as willing to lend to someone with a bad credit rating, as someone with a good credit rating.
Normally someone with bad credit would be locked out of the market, but with P2P lending you now have another option, and quite often you will be able to find someone willing to finance you. That’s the beauty of the system, many investors like the higher rate of return they can get through issuing a loan to someone with a so-so credit history. They take on the risk looking for a better return, and the borrower gets another chance to prove they can meet the repayments and pay off the debt.
Peer to Peer Lending for Investors
I personally really like the idea of getting into peer to peer lending if you are an investor. It looks like a great way to diversify your investment portfolio and in my opinion the rewards seem to outweigh the risks. I also recently added peer to peer lending as one of the ways you might want to invest $10,000 as it really does seem like too good of an opportunity to pass up.
Disclosure of Material Connection: Some of the links in the post above are “affiliate links.” This means if you click on the link and purchase the item, I will receive an affiliate commission. Although please note: I only recommend products or services that I believe will be of use to my readers.