What is peer-to-peer (P2P) lending?

The internet has been a boon for many sectors, and undeniably it has facilitated the adoption of several alternative methods of financing. Websites and even mobile applications  are promoting social lending or crowdlending, and the existence of peer-to-peer (P2P) lending platforms is shifting interest from mainstream lending practices. 

Here we take a look at a more detailed peer-to-peer lending definition and its implications for traders and investors. 

Peer-to-peer lending means that individuals can obtain loans directly from other individuals, without engaging financial institutions as the middleman. 

Websites that enable P2P lending have gained popularity and increased adoption globally. They connect investors to individual borrowers directly, and set the rates and terms of the transaction. While the interest rate is based on the creditworthiness of the borrower, the transaction process is completely automated and allows both lender and borrower to negotiate.

How does peer-to-peer lending work?

P2P lending platforms are the key to this process, and have set regulations for both lender and borrower. The lender has to open an account and deposit a sum of money to be dispersed in loans, while the borrower posts a financial profile on the website which is assigned a risk category that determines the interest rate they will need to pay.

Both the lender and borrower can review offers and accept the one they deem most favorable, and in several cases open negotiations. Once selected and approved, the transfer and monthly payments are handled through the platform, making the process automated.  

Below are some of the risks and benefits of peer-to-peer lending:

Risks

• There is a risk of default on interest payments, or even principal repayment, if the P2P platform fails to vet the borrower

• A high amount of lending to a specific borrower may be risky in case the borrower defaults

Benefits

• Generates returns in the form of recurring monthly interest payments

• Borrowers’ creditworthiness is determined by a credit score

• Low minimum lending amount 

Peer-to-peer lending example

Some of the leading P2P lending platforms include StreetShares, Lending Club, Happy Money, Upstart, and Peerform. StreetShares is designed for small businesses and also engages community banks and credit unions to provide a loan. 

Peer-to-peer lending can also include student loans, payday loans, commercial and real estate loans, and other secured business loans, leasing, and factoring. Companies like Lending Club have categories like ‘Patient Solutions’, which links doctors who offer financing programmes with prospective patients.