Peer to peer lending or P2P is a lending money directly to businesses and individuals without any official financial institutions joining as an intermediary in the money lending deal. P2P lending is generally performed through online platforms that effectively match lenders with potential borrowers.

Peer to peer lending provides both unsecured and secured loans. Nevertheless, most loans under this type of lending are unsecured personal loans. The secured loans are rare in the lending industry, and certain luxury goods commonly back these. Because of some special characteristics, the peer to peer lending is widely considered as an alternative financing source.

Learn More about Peer to Peer Lending

P2P lending is also referred to as crowdlending. Plenty of peer to peer loans are unsecured although some of the biggest amounts is being lent to business. Some instances secured loans are provided using making use of luxury assets like fine arts, watches, vintage cars, jewelry, aircraft, buildings and many other assets as collaterals. These are made to charity, company or individuals. There are other forms of P2P lending, and these are real estate and commercial loans, payday loans, student loans, and secured loans, factoring and leasing.

Interest rates are set by lenders competing for the lowest rate in the reverse auction models or fixed by an intermediary company based on the analysis of borrower’s credit. A government guarantee doesn't normally safeguard the investment of the lender in this loan. In certain services, lenders mitigate risks of bad debts by selecting the borrowers to be given money and also mitigate risks through diversifying investments among many different borrowers. Some other models include P2P lending companies that maintain separate ring-fenced funds that pay the lender back when borrower defaults but at some point, this is still subject to some arguments.

Peer to Peer Lending-How Does it Works?

The peer to peer lending is a straightforward process. All transactions are done via specialized platform online. The following steps describe the common peer to peer lending process:

• A potential borrower who plans to obtain the loan must complete the online application form in the P2P lending platform.
• Such lending platform will assess the loan application and will determine the applicant’s credit rating and risks. The applicant will then be assigned with the right interest rate.
• As soon as the application gets approved, the loan applicant will receive available options and pick one of these options.
• Also, the applicant needs to pay periodically, usually every month the interest and repay the principal amount when it reached maturity.

Characteristics of Peer to Peer Lending

Peer to peer lending doesn’t cleanly fit any of the three common types of traditional financial institutions like insurers, investors and deposit takers and at times categorized as Alternative Financial Service.

The following are the typical characteristics of peer to peer lending:

• Peer to peer lending is sometimes performed for profit
• Transactions mainly happen online
• No necessary prior relationship or common bond between borrowers and lenders
• Lenders might often select the borrowers to invest if the peer to peer lending platform provides such facility
• Loans are considered securities which can be transferred to other people either for profit or debt collection although not all peer to peer lending platforms offer free pricing and transfer facilities choices. The costs can be ultimately high.
• Loans can be secured or unsecured and aren’t generally protected by government insurance. However, there can somehow be protection funds.

Peer to peer lending is also characterized by a reliance on social media and disintermediation, but these features begin to disappear. While it’s true that emergence of ecommerce and internet makes it highly possible to do away with the traditional financial intermediary and that individuals might default to the members of their very own social securities, the emergence of newest intermediaries proved to be cost and time-saving.

Also, extending the crowdfunding to the unfamiliar borrowers and lenders can open up to new and better opportunities. The following are services provided by most peer to peer lending intermediaries:

• Legal reporting and compliance
• Development of the credit models for the approval and pricing of loans
• Verifying the identity of the borrower his income, employment, and bank account
• Processing payments from the borrowers and then forwarding such payments to lenders who invested on loans
• Online investment platforms that enable borrowers to attract investors and lenders to identify as well as buy loans that meet their unique investment criteria
• Finding new borrowers and lenders
• Performing credit checks on borrowers and then filtering out those unqualified borrowers who are either in default or are delinquent

Pros and Cons of Peer to Peer Lending

Pros:

P2P lending offers significant advantages to lenders and buyers alike, and these include the following:

• Higher Returns to Investors. Peer to peer lending commonly offers higher returns to investors as compared to other forms of investments.
• Lower Interest Rates. Peer to peer lending loans often come with lower interest rates due to greater and tougher competition between lenders. The loans also come with lower origination fee.
• More Accessible Funding Source. For certain borrowers, P2P lending tends to be more accessible sources of funding than the conventional loans provided by the lower credit rating of borrowers or uncommon purpose of loans.

Cons:

Peer to peer lending also comes with a few disadvantages.

• Credit Risks. P2P loans are exposed to higher credit risks and numerous borrowers applying for peer to peer loans display bad or low credit ratings. This doesn’t allow them to obtain traditional loans provided by banks. Lenders should, therefore, be aware of the probability of default of borrowers.
• No Government Protection or Insurance. The government doesn’t provide insurance or any protection to lenders in case borrowers default.
• Legislation. Certain legislations don’t allow a peer to peer lending or these require companies to offer such services to meet the set investment regulation. Thus, peer to peer lending might not be available to some lenders or borrowers.

Upon learning all these, individuals can now decide if peer to peer lending or loans is suited for their financial situation or not.