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Home Business

What is Peer-to-Peer (P2P) Lending?

by msz991
December 8, 2020
in Business
4 min read
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peer to peer lending
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Peer to peer or p2p lending is an alternative for traditional bank loans. The majority of P2P loans are personal loans that borrowers can use for different purposes from home improvement, small business loans to debt consolidation. 

Table of Contents

  • What Are Peer-to-Peer Loans?
  • Pros and Cons of P2P lending for Lenders 
  • Pros and Cons of P2P Lending for Borrowers
  • How to Apply for a P2P Loan

What Are Peer-to-Peer Loans?

P2p loans are different from traditional credit union or bank loans. While getting a bank loan, the bank uses some of its assets that are the deposits by other customers, to fund the loans. With p2p lending, investors are matched with borrowers directly through an online lending platform. Lenders can see and choose the loans they want to fund. Most commonly, p2p loans are small business loans or personal loans. Peer to peer lending is also known as social lending or person to person lending. The companies that make p2p loans are called marketplace or peer to peer lenders. 

A peer to peer lender places restrictions on the type of people who can invest in their loans. However, some platforms are open to everyone as long as they meet the account minimums. Some companies are only open to accredited lenders or qualified buyers. You are considered an accredited investor when you have a yearly income of £100,000 or net assets (excluding home, life assurance, pensions and mortgage) more than £250,000. Also, there are p2p platforms that are only open to institutional investors like commercial banks, hedge funds, endowment funds or pension, and life insurance companies.

Marketplace lenders earn profit by charging a fee to borrowers. Also, they take a percentage of the interest generated on loan. Typically, lenders charge an origination fee, usually 1% to 6% of the loan amount, and the late payment charges to the borrower. On the investing side, marketplace lenders take a percentage of the interest earned on loans.

Pros and Cons of P2P lending for Lenders 

Peer to peer funding is not for every lender or borrower since it has a unique set of benefits and drawbacks. 

Pros

  • Access to different investment opportunities other than stocks & bonds
  • High-interest rate compared to standard savings accounts
  • A sense of community by lending to peers directly
  • Majority platforms allow automatic diversification on your loan portfolio

Cons

  • The Financial Services Compensation Scheme does not cover P2P loans (FSCS).
  • Risk of losing money if borrowers default
  • Some platforms are only open to accredited investors. 
  • Less liquidity than stocks and bonds because of long time horizons (three to five years)
  • Relatively new industry means instability

Pros and Cons of P2P Lending for Borrowers

Pros

  • Automatic repayment 
  • The lower range of interest rates
  • Fast and online experience 
  • Credit requirement less strict compared to bank 
  • Can check rate without affecting credit score
  • Fixed monthly payments
  • Flexible use of funds
  • No prepayment penalties 
  • Most loans are unsecured

Cons

  • Cannot qualify with a credit score less than 630
  • Missed payments can hurt credit score 
  • Cant typically borrow more than 
  • High-interest rates up to 36% if you have below-average credit
  • Can’t borrow more than £35k
  • Some sites have high fees, including origination fees up to 6%

How to Apply for a P2P Loan

The majority of peer to peer lenders allow you to check your rate and apply online. Usually, you can apply online in just a few minutes. Every lender has its unique requirements. For personal loans, this includes your salary, credit score, employment status, credit history, and debt-to-income ratio. For business loans, this includes your personal and business credit score, time in business, revenue, profits and your debt service coverage ratio. Marketplace lenders can only lend to borrowers who are of the age 18 or above and UK resident.

Generally, you will have to provide your personal information like name, date of birth, email, address, and phone number. Also, for personal loans, you will have to provide information about your mortgage payments or housing, educational history, employment status, salary, any outstanding debts, and details on the loan you want. You may have to get all this information verified. For business loans, you will have to provide information like business financials and if needed documentation, including balance sheets, returns, and profit and loss statements.

Once you have applied online, the lender may present with different loan offers. Once you select an offer, you will have to submit a hard credit check as well, which affects your credit score. Majority of peer to peer lenders give loan decisions quickly, either on the same day or within a few days. Also, funding is quick, with most borrowers getting funded within two to fourteen days.

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