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What is Peer-to-Peer Lending and How Does it Work?

In recent years, lenders looking for small loans with competitive interest rates have turned to peer-to-peer lending (P2P) as a way to sidestep big financial institutions who have stopped lending money as freely as they used to, helping P2P investing become one of the fastest growing segments in the financial services industry. Born out of the 2008 financial crisis, the peer-to-peer lending model began when some companies started to developed online platforms where potential investors looking to earn returns on cash sitting in savings accounts could connect with borrowers looking for more options.

 

Sometimes called “social lending” or “crowd lending”, peer-to-peer lending companies act as the liaison between borrowers and investors through an internet platform – completely cutting banks out of the process. These lending platforms generate revenue by collecting a loan servicing fee to investors and by applying fees on funded loans from borrowers. After the loan has been funded, the money is released to the borrower by a partner bank and the loan company issues a note to the investor that acts as a form of security.

 

The lower operating costs and interest rates have made P2P lending a major competitor for the traditional banking system – and an appealing option for borrowers hunting for low-interest personal loan companies looking to diversify their investment portfolios. The streamline method also means that there is a fast turnaround for funding and fees are lower, with some peer-to-peer lenders not charging any penalties to borrowers for late or early payment.  

 

Borrowers tend to be people looking for unsecured loans of $1,000-$35,000 payable over 3-5 years, who don’t have access to home equity credit. These are often to help pay for small purchases - a used car, home repairs, and so on - or to consolidate their debt with a lower interest loan. Lenders tend to be individuals investing from $5,000 to $25,000, spread across a series of small, $25-$100 loans to minimize default risk. They are looking to sidestep banks and find investments that pay higher than traditional methods such as bank accounts and Certificates of Deposit (CDs).

 

Pros for Investors:

Lower risk 

If you’re a lender on a peer-to-peer site you have real freedom to pick and choose where to invest your money. If you’re worried about the borrowers you can keep your investment very low or just spread it across a portfolio with hundreds or even thousands of loans in order to offset the risk. 

Better yields

It’s not chiseled in stone, but peer-to-peer investors have the opportunity to get better returns on their money than they would with more traditional, conservative investments like stocks, bonds, mutual funds, and the like.  

Easy to get started 

Getting in the game is easy. You can open an investment account online easily and in no time. You can start off by investing small amounts - even as little as $25 - and then reinvest the earnings back into new loans. Managing your account is easy, you maintain total autonomy and getting up and running should be easier than you probably expected. 

 

Pros for Borrowers:

Better rates 

P2P sites connect the borrower and the lender directly, easily facilitating loans without you ever having to step foot inside a bank. What does this mean for your bottom line? Because P2P sites have less overhead and spread their risk over many lenders, you can often find a lower APR on a P2P site than at a traditional financial institution. This of course does depend to a large extent on your credit score, but the opportunity to save money on your loan is there with P2P lending. 

Easier application process 

When getting a P2P loan you can go online and get pre-approved within minutes. These sites have online applications that take very little time whatsoever, and you never have to go to your bank branch or even get out of bed if you don’t want to. You’ll still have to get your paperwork in order - including documents like bank statements, pay stubs, and the like, but the entire process should be much smoother. 

Fixed rates and no prepayment fee

With P2P loans you will most likely have a very clearly fixed repayment terms (typically of 24 or 36 months) which should help you manage and plan your monthly expenses. There won’t be any surprises and you’ll always know how much you own. Also, P2P lenders tend to not charge a fee for prepayment, if you come into some money and would like to pay your loan off early. 

Get money faster 

Typically the process is quicker with P2P lending and you should receive your funding within a week or two, and in some cases, within several days.

 

Cons for Investors:

Can lose money 

While it’s true that with peer-to-peer lending you get to diversify your portfolio to offset risk, this is by no means fool-proof. This is especially true if you go for more high risk portfolios. They do yield greater returns, but this comes with a higher degree of risk. Spread your loans out across a large portfolio and play it cautious at least at first. In addition, you are not allowed to cut your losses and sell the loan ahead of time – you are bound to the commitment made at the time of lending, which is typically for a matter of years. Also, your loans aren’t guaranteed by the federal government, so you could be left hung out to dry if the borrowers default. 

Harder to know your client

While offsetting the risk across a wide range of borrowers is a smart move, with P2P lending you’re also much less able to know your clients personally. This means you’ll have to trust the company’s determination of the risk involved with the borrower, instead of deciding on your own after performing due diligence. 

 

Cons for Borrowers:

Bad credit? It still won’t be easy 

You’ll probably find that with P2P lending you have an easier time getting a loan with poor credit than you would with a traditional bank. At the same time, you’ll probably pay for this by way of higher APRs, which could make it difficult to make your payments, potentially drawing you into further debt. Depending on the company, these APRs for people with bad credit can be very steep, even significantly higher than the interest on credit cards. 

Don’t forget the fees 

In addition to APR, with a P2P loan you’ll also have to pay origination fees, which can hover around 4% to 5% depending on the company and your credit score. These fees are typically deducted from the loan amount, which can offset the amount of money you’re actually getting. In addition, you’ll probably face additional fees for late or failed payments.

 

Top Peer-to-Peer Companies

Peer-to-Peer lending has opened up opportunities for financial assistance for countless people who may have had limited options otherwise. Some of the top sites for personal loans process P2P lending on a large scale, with rates and fees that can appeal to a wide variety of budgets. Compare 3 of the top peer-to-peer lenders below:

SoFi

1. SoFi

SoFi​ is a major force in the peer to peer lending industry and offers a wide range of loans, including MBA loans, mortgage loans, parent loans and all types of personal loans, as well as wealth management services.

SoFi is a great choice for 2 types of borrowers in particular: people with good credit and young people who are looking to refinance college loans.

The company requires a minimum credit rating of 680 and can facilitate some of the better rates in the industry for people who qualify. If you are a borrower looking for a student loan refinance, SoFi will look beyond just your credit score, and take a look at your education history as well as your post-graduation employment and employment. What this means is that if you’re a young person who still hasn’t built up a strong credit history, you can still get a loan with good rates.

SoFi can also provide lenders with networking and career advice, which can really help out a young borrower straight out of college who is looking to refinance student loans.

There are other appealing features of SoFi, including the fact that the company doesn’t charge late fees and lets you change the due dates for your payments. It also doesn’t set a maximum debt to income relation and can temporary freeze the loan repayment if you lose your job.

Approval typically takes a little bit longer than with other companies, but once approved, you should receive your money in a matter of days.

 

  • Personal loans up to $100,000
  • Low APR rates for student loan refinancing - from 2.2% variable to 3.5% fixed
  • Unemployment protection - freezes loan payment schedule if you lose your job
  • It requires good credit, and is geared for those with a score of at least 680, as well as regular income and strong employment history
  • APRs ranging from 6.26% - 15.12%

 

LendingTree

2. ​LendingTree

For the past 20 years, ​LendingTree​ has helped facilitate P2P loans between reliable lenders and borrowers looking for the best rates possible. Instead of filling out multiple loan requests with various lenders, you file a single one with LendingTree and they do the legwork, finding P2P loans from a wide variety of lenders that meet your needs and sending the details your way. 

One very appealing feature of LendingTree is that it doesn’t have a set minimum credit score. Now, obviously the better your credit score the better the loan terms you’ll receive, but the bottom line is that LendingTree is a very solid option for borrowers who may have been shut out elsewhere because of their credit score. 

With loans ranging from $1,000 to $50,000, the company is also a good option for people who don’t need to borrow an especially large amount of money. 

In addition, LendingTree doesn’t charge you any fees for connecting you with loan providers. 

People who may have specific budget needs can also benefit from the flexibility of LendingTree, which can facilitate loans with repayment terms from 3 months to 180 months. 

  • Secured and unsecured personal loans available
  • Loans range from $1,000 to $50,000, with repayment plans of 3-180 months
  • Borrowers aren’t rejected solely based on a low credit score
  • APRs can range from 4.79%-35.99% depending on your credit and the terms of the loan

 

LendingClub

3. Lending Club

Lending Club has become a major P2P lender by helping customers - including ones with low credit scores - find all types of loans from personal to home improvement to debt consolidation loans. The company is entirely online and offers a variety of attractive terms to help borrowers find loans that can help them get a leg up on their financial future. 

The company requires a credit score of 600, which means that even people with fair credit can qualify for a personal loan. The company also allows up to a 40% debt to income ratio, which is quite high, and you should be able to complete the application process and receive your funds within a week.

The company can facilitate loans of 3-5 years for between $1,000 to $40,000. This is pretty standard for the industry, but is less of a range of payment options as some other companies in the industry.

  • Loans available from $1,000 to $40,000, payable over 3 or 5 year plans
  • Accepts borrowers with low credit
  • APR from 6.95% to 35.89%
  • ”Medical loans” - can offer 0% loans to help augment costs of medical bills
  • No hidden fees for sign up or loan processing
 

What Types of P2P Loans Are Available?

There are 4 main types of loans available with P2P lending, all of which are basically different forms of personal loans.

Unsecured personal loans

This is a very popular form of loan that borrowers often find to be less of a headache. An unsecured personal loan is one that doesn’t require you to put any collateral down to “secure” the loan. The good thing about this type of loan is that you don’t need to risk your house or car or some other form of valuable collateral, but this doesn’t come without a price. If you don’t secure the loan you stand to pay a higher APR, as you will be seen as a more risky borrower.

Secured personal loans 

If you do have collateral to put on your loan, then this may be your best option. With a secured personal loan you will have given the bank an insurance policy of sorts by way of your collateral. This will make you less of a risk for the bank, which should pay off for you by way of lower APR.

Debt consolidation 

Done right, this can be one of the smarter, more financially-sound ways to use P2P lending to your advantage. If you have previous, high interest debts - such as credit cards or student loans - a P2P personal loan can be a great way to pay those loans off and consolidate your debt. It probably goes without saying though that this is only the case if the new loan has better terms. See what you can do to get the best terms possible, and a P2P loan to pay off those high-interest debts could really take the edge off.

Business loans

There are a number of options for entrepreneurs who are looking to get a business off the ground or just need some more cash flow to help their business soar. These can include Small Business Administration loans, microloans, and term loans, to name a few. With P2P lending you can also get a secured or unsecured personal loan which you can towards whatever it is your business needs.

 

Loans For Small Purchases, From Your Smartphone

One of the main draws for P2P lending is the customer experience, and the large number of lending companies consumers can choose from. Borrowers can shop interest rates without leaving the house and lenders can track their portfolio with a few clicks on their smart phone. Both lender and borrower can bid adieu to long lines at their local bank branch, where approval for a loan can take days rather than mere minutes on a P2P platform.

 

Lending companies make their money by charging fees to borrowers, taking a percentage of the loan repayments to investors, and collecting fees for defaulted loans, in addition to other service fees.

 

We recommend potential investors and borrowers read reviews of some of the industry’s top P2P platforms, including SoFi and LendingTree.

 

What to Consider:

Hidden Fees

Although P2P lending provides significant advantages to both investors and borrowers, you still need to do your homework. One thing to note is there are fees involved – including origination fees - that can range from 0.5% to more than 5% of the loan. Be sure to read the fine print and fully understand the total cost of the loan by the time it’s paid off.

Some lending companies charge contributions to “bad-debt provision funds” – which are set aside to help protect the lending company from losses. Because the loans are taken out with no collateral, P2P companies can sell the defaulted loans to a collection agency or take out a court order against the borrower.

 

Rise in Interest Rates

An average interest rate of a peer-to-peer loan is roughly 15% but if you have fantastic credit you can get rates as low as just over 5%. That said, those with poor credit can get stuck with much higher interest rates – as high as 30.99% for the riskiest borrowers at Lending Club – an industry leader.

Experts believe that if interest rates continue to increase, the industry could see higher costs for borrowers – and better returns for investors – perhaps leading to a bubble in the industry. Regardless, average interest rates on P2P loans are not likely to exceed those of credit cards, and as long as the economy is doing well and unemployment remains relatively low, the number of defaults shouldn’t raise any red flags.

 

Loan Term

Most peer-to-peer loans are only three to five year, fixed monthly payments, though many loans are stretched out over a longer period, with lower monthly payments and higher interest rates. This is yet another reason these loans are becoming favored - low interest with a fixed term for the repayment.

 

Bad Credit

Prior to 2008, lenders were focused on borrowers with credit scores over 640. Today, some P2P sites welcome borrowers with scores as low as 580, though they stand to pay higher interest rates than lower risk borrowers. In addition, some of the top peer-to-peer lenders look beyond just your credit score, factoring in considerations such as work history.

 

Regulations

In 2008 the Securities and Exchange Commission began to regulate the P2P industry and on the borrower side, agencies such as the Consumer Financial Protection Bureau and Federal Trade Commission now regulate the P2P industry. P2P platforms are subject to the same federal rules that govern all consumer credit company such as Equal Credit Opportunity Act and Fair Debt Collection Practices Act and borrowers are protected by state regulations against misleading advertising and discriminatory practices.

 

In 2016, growth for the P2P industry began to stumble under heightened regulation, leading many financial analysts to question predictions that the online lending platform poses a threat to traditional banking. Nonetheless, the industry is still on the rise and P2P loans remain an inexpensive way to tackle multiple debts at once and help you make your dreams come true. We just want you to make sure that it is something you are prepared for and ready to face head-on.

 

So, What’s Next?

It’s up to you to determine if a peer-to-peer loan is the right way for you to get on the road to being debt free or a ticket to higher returns on investment than your bank account or CD. If you compare peer-to-peer loans that are available and do some homework you can take part in an industry that is user friendly and has great potential for reward – all from the comfort of your home. For more information on P2P loan companies, read our reviews of top companies.

 

APR Rates

The APR calculation on personal loans varies according to lender, but the rates on these loans are generally lower than what you would typically receive from a payday loan, starting at 10% and capping at 35.99%

APR rates mentioned include associated fees.

Full repayment for the loans displayed range between 61 days to 180 months.

 

Representative example: assuming a loan of $10,000 over 60 months at a fixed rate of 3.1% per annum and fees of $60.00. This would result in a representative rate of 3.3% APR, with monthly repayments of $180.80, for a total amount paid of $10,848.00.

 


LightStream Terms and Conditions:

APR Disclosure: Your APR may differ based on loan purpose, amount, term, and your credit profile. Rate is quoted with AutoPay discount, which is only available when you select AutoPay prior to loan funding. Rates under the invoicing option are 0.50% higher. Subject to credit approval. Conditions and limitations apply. Advertised rates and terms are subject to change without notice.

Payment Example: Monthly payments for a $10,000 loan at 4.99% APR with a term of 3 years would result in 36 monthly payments of $299.66.

Same-Day Funding Disclosure: You can fund your loan today if today is a banking business day, your application is approved, and you complete the following steps by 2:30 p.m. Eastern time: (1) review and electronically sign your loan agreement; (2) provide us with your funding preferences and relevant banking information; and (3) complete the final verification process.

 

** Marcus By Goldman Sachs® Offer Terms and Conditions:

Your loan terms are not guaranteed and are subject to our verification of your identity and credit information. To obtain a loan, you must submit additional documentation including an application that may affect your credit score. Rates will vary based on many factors, such as your creditworthiness (for example, credit score and credit history) and the length of your loan (for example, rates for 36 month loans are generally lower than rates for 72 month loans). Your maximum loan amount may vary depending on your loan purpose, income and creditworthiness. Your verifiable income must support your ability to repay your loan. Marcus by Goldman Sachs is a brand of Goldman Sachs Bank USA and all loans are issued by Goldman Sachs Bank USA, Salt Lake City Branch. Applications are subject to additional terms and conditions.