Peer-to-peer (P2P) lending enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman. Online platforms that facilitate P2P lending have greatly increased their adoption as an alternative method of financing.
P2P lending is also known as “social lending” or “crowd lending.” It has only been around since 2005, but the crowd of competitors already includes influential names like Prosper, Lending Club, Upstart, and Funding Circle.
Key Insights
- What Is P2P Lending? - Peer-to-peer (P2P) lending is a form of financial technology that allows people to lend or borrow money from one another without going through a bank.
- Direct Connections - P2P lending platforms connect borrowers directly to investors. The sites set the rates and terms and facilitate the transactions.
- Investor Advantages - P2P lenders are individual investors seeking higher returns on their cash savings compared to those offered by traditional saving accounts or certificates of deposit.
- Borrower Benefits - P2P borrowers look for an alternative to traditional banks or lower interest rates.
- Higher Default Rates - Default rates for P2P loans are generally much higher than those in traditional finance.
Delving Into Peer-to-Peer Lending
P2P lending websites connect borrowers directly to lenders. Each platform sets the rates and the terms and enables the transaction. Most sites display a wide range of interest rates based on the creditworthiness of the applicant.
Firstly, an investor opens an account with the platform and deposits a sum of money to be distributed in loans. The loan applicant posts a financial profile that is assigned a risk category, determining their interest rate. The loan applicant can then review offers and accept one. (Some applicants break up their requests into chunks and accept multiple offers.) The money transfer and monthly repayments are managed through the platform. The process can be entirely automated, or lenders and borrowers may choose to negotiate.
Some sites specialize in particular types of borrowers. For instance, Funding Circle focuses on small businesses, while Lending Club has a “Patient Solutions” category linking doctors who offer financing programs with prospective patients.
A Brief History of Peer-to-Peer (P2P) Lending
Initially, the P2P lending system was perceived as offering credit access to individuals spurned by conventional institutions or a means to consolidate student loan debt at a more favorable interest rate.
In recent years, however, P2P lending sites have expanded their reach, targeting consumers who desire to pay off credit card debt at lower interest rates. Additional options such as home improvement loans and auto financing are also available on P2P lending sites.
The rates for applicants with good credit are frequently lower than comparable bank rates, while those with less favorable credit records may encounter much higher rates. As of December 2023, personal loan rates ranged from 6.40% to 36%, while the average credit card interest rate stood at 21.19%, according to the Federal Reserve.
For lenders, P2P lending presents an opportunity to earn interest income on their cash at rates surpassing those offered by traditional savings accounts or certificates of deposit. Some P2P platforms even allow lenders to start with an account balance as low as $25.
Things to Consider
Individuals interested in lending money through P2P sites should consider the possibility of borrowers defaulting on their loans, just like conventional banks. Research on P2P lending platforms indicates that defaults are significantly higher compared to traditional financial institutions, sometimes exceeding 10%.
By comparison, the Federal Reserve’s index of delinquency rates on loans at all commercial banks fell from approximately 3.76% to 1.32% over the decade leading up to December 2023.
Any consumer or investor considering a P2P lending site should also scrutinize the transaction fees. Each site monetizes differently but may charge fees and commissions to the lender, borrower, or both. As with banks, P2P platforms might impose loan origination fees, late fees, and bounced payment fees.
Is Peer-to-Peer Lending (P2P) Safe?
P2P lending is riskier than traditional savings accounts or certificates of deposit, but the interest rates are often higher. This is because investors on P2P lending sites assume most of the risk usually absorbed by banks or financial institutions.
Market Potential of Peer-to-Peer (P2P) Lending
The global peer-to-peer lending market was valued at $134.35 billion in 2022, according to data from SNS Insider. This figure is projected to grow to $705.81 billion by 2030.
How to Invest in Peer-to-Peer Lending
The simplest way to invest in P2P lending is to create an account on a P2P lending site and begin lending money to borrowers. These platforms generally allow lenders to select the profiles of their borrowers, ranging from high risk/high returns to more modest returns. Additionally, many P2P lending platforms are public companies, so one can invest by purchasing their stock.
Final Thoughts
P2P lending platforms offer various options for entrepreneurs, small businesses, and individuals who may not meet traditional banking standards. While P2P lenders may extend credit more readily, it usually comes with higher fees and interest for borrowers and a higher risk of default for lenders. Many P2P platforms simplify the process of investing or borrowing, but it’s crucial to read all associated fees before committing.
Related Terms: Crowd Lending, Social Lending, Fintech, Direct Lending, Micro-lending, Online Borrowing.
References
- Zopa. “About Us”.
- Funding Circle. “About Us”.
- Lending Club. “Patient Solutions”.
- LendingTree.com. “Compare Personal Loans for July 2023”.
- Board of Governors of the Federal Reserve System. “Consumer Credit-G.19”.
- Springer Open. “How Does an Individual’s Default Behavior on an Online P2P Lending Platform Influence an Observer’s Default Intention?”
- Board of Governors of the Federal Reserve System. “Delinquency Rate on All Loans, All Commercial Banks.”
- SNS Insider. “Peer to Peer Lending Market”.
- Precedence Research. “Peer to Peer Lending Market Size, Report 2023–2032”.
