What is Peer-to-Peer Lending?
Peer-to-Peer (P2P) lending allows individuals to obtain loans directly from others, removing the need to obtain the loan from a financial institution. In recent years, P2P lending has increased dramatically in popularity as an alternative means to obtain needed financing.
Since its adoption in 2005, various companies have created online platforms for P2P lending. Some of the main players include Lending Club, Prosper, Peerform, and Upstart. Some P2P lenders have guidelines on who they allow to invest in their platform.
How Does Peer-to-Peer Lending Work?
P2P lenders are the link between the consumer and the individual investors. The lender sets the terms and the interest rate of the loan based on underwriting algorithms and creditworthiness of the borrower. A borrower who applies with better credit history will have more favorable loan terms than a borrower with poor credit history. A better credit history results in a lower interest rate, and the investors will see this loan as less risky of an investment.
The investor first opens an account with the lender and deposits money to be placed between multiple loans on the platform. The investor may assess the risk of each individual loan and decide whether or not to invest in certain loans if they believe the borrower may or may not default on the loan.
It is important for investors to assess the risk and possible reward of investing money in P2P lending. An investor may have the potential to earn 10% back on their money, in hopes that the borrowers they invested in will default at a rate much lower than 10% to still make a profit on their investment.
Some lenders specialize in a particular type of loan, such as student loans, small business loans, personal loans, auto loans, debt consolidation, and many other types of loans. P2P lending has allowed many borrowers to obtain funding with lower interest rates and consolidate their debts into one single payment. Loans from P2P lenders are installment loans, which means that the loan payments are broken down into substantially equal payments.For more financial terms and definitions, return to the Glossary home page.