Also known as Crowd Lending or Social Lending, Peer to Peer Lending or P2P lending is a facility which allows individuals to get loans from others, without the involvement of financial institutions in a very hassle free way. This method of lending has gained a lot of popularity and people are now getting familiar with its concept. This piece dives deeper into the world of Peer to Peer lending and discusses in detail the various nuances of how it works, how it originated and all the other aspects that are important for the understanding of the concept.
Peer to Peer is a lending facility whereby the websites connect borrowers to lenders, directly, without any mediators. This whole mechanism takes place through websites, each having their own rates and terms and conditions. Also, most of the websites have different interest rates which depend on the creditworthiness of the person applying.
The whole mechanism has a lot of transparency and flexibility which makes it more desirable and appealing. Borrowers also have the liberty to choose whether they want the whole process to be automated or manual. There are also a variety of sites which specialize in different types of borrowers. Their services cater to the requirements of some specific types of borrowers. Now that we know what Peer to Peer lending is, let’s take a look at how it works.
How does Peer to Peer lending work?Â
All the transactions in Peer to Peer lending is conducted in a very dignified way and the process is also very simple and straightforward without much space for complications.
This is how the lending process takes place:
1. The first step is to fill an online application form on the lending platform by the borrower who wants to avail the loan.
2. The application is then evaluated by the website to analyze the creditworthiness of the borrower. After the evaluation is done the borrower is assigned with the interest rate.
3. After the application receives approval, the applicant gets to know about the several options he/she has from the investors on the basis of his credit ratings and the interest rates assigned.
4. The applicant then has to evaluate all the recommended options and choose the one which suits his/her requirements the best.
5. After everything is done, the applicant is required to pay an interest amount which is usually on a monthly basis, and the principal amount at the time of maturity. The company that maintains the Peer to Peer platform levies certain charges on the borrowers as well as the lenders for using the platform and its services.
A Look at Peer to Peer Lending History
Quite evidently, what gave rise to the concept of Peer to Peer lending is people’s requirement for funds. Peer to Peer lending originated as a facility to make credit easily accessible for those who are not able to have easy access to financial institutions. Another reason which helped proliferate the concept of Peer to Peer lending is the easy provision of student loans to students at a more favorable interest rate so that they are able to have easy access to it in a hassle free way.
However, Peer to Peer sites have now expanded their reach to home improvement loans, auto financing and to fulfill the requirements of those consumers who want to pay off their credit card debt at less interest rates, as well. Rates depend on the creditworthiness of the borrower. For a borrower with a good record, the rates are less and for a borrower whose creditworthiness is not very reliable, the rates are high.
Advantages of Peer to Peer LendingÂ
Advantages for the borrower:
1. First of all the complete process is online so it’s very easy and convenient.
2. If the borrower has a good credit score, P2P lending sites offer very lucrative interest rates which are even better than banks and other financial institutions.Â
3. In case a borrower has lower credit ratings, he/she will still be able to avail the loans but they will be given a smaller amount.
4. After borrowing, in case you no longer are in need of the borrowed money, the P2P lending platforms also provide you the facility of paying off your loan early or making an over-payment without any penalties.Â
5. There is no bar on the purposes for which you are borrowing money. You can borrow money to fulfill any type of requirement.
Advantages for the lender:
1. Lenders get to have a higher rate of return in comparison to other investment options.
2. Lender is the one who gets to decide the level of risk he wants to take depending on his capacity to bear. They can check the profile of the borrowers and choose which borrower they want to lend to depending on the credibility score.
3. To protect the lenders against the default on loans, some sites have contingency funds as well.
4. If you make an investment through an Innovative Finance Individual Savings Account (IFISA), the income that you would receive through P2P lending would be tax free.
Disadvantages of Peer to Peer Lending
Disadvantages for the borrower:
1. The borrower might have to pay some additional fees apart from the interest that he/she is entitled to pay for the amount borrowed.
2. If borrowers have poor credit rating, then they have to pay a higher rate of interest. There is also a possibility that you might not even get a loan if your credit rating is very poor.
3. If you have some trouble in repaying the loan, you are not likely to receive the same protection which you would have received, had you borrowed from the traditional means of lending. If you are not able to repay, you might land yourself into legal problems.
Disadvantages for the lender:
1. The amount of loans you give is not covered under the Financial Services Compensation Scheme. Therefore, if you get trapped in a default, you’ll have to bear the financial loss.
2. During a loan agreement, if you want your money back, then you will first have to find another lender to take the loan. Although the P2P lending site will arrange all this for you, the process is not quick and hassle free. You may also be charged some fees.Â
3. If the borrower you have lent money to returns before time, then the returns paid will be low and you’ll be receiving less interest for the money you lent.
Is Peer to Peer Lending Safe?
There is no doubt as to the fact that there indeed is a lot of risk involved in P2P lending. As lenders, if a person wishes to lend money he/she needs to consider the possibility that the borrowers might conduct a fraud with them.
Defaults are very common in P2P lending. The interest rates are also therefore very high, because in case of P2P lending people who invest take up most of the risk. The parties involved in P2P lending are also advised to check the fees on the transactions because although every site charges differently, the fees or commissions might be charged to the borrowers or the lenders or both.
How To Invest in Peer to Peer Lending?
The simplest and the most common way to invest in P2P lending is to create an account on the lending site after which you can start lending to borrowers. Mostly, these P2P lending sites allow the borrowers to choose the profile of their borrowers so that they have the liberty to choose between high, low or moderate returns.
Finally
Peer to Peer lending, while being a massively useful and effective concept, has yet to emerge completely. Considering the fact that it has not gained much popularity and has a significant amount of risk associated with it, it will take some time for it to gain people’s trust and confidence. As more and more people get involved into this mechanism, the methods to minimize defaults and frauds will also emerge to make Peer to Peer lending websites a safe platform for people.
