Peer-to-peer lending allows individuals or businesses to borrow money directly from others, without involving a financial institution. Learn more here.
You might have many reasons for needing extra money to get your finances in order. Maybe you have a sudden emergency that you haven’t saved for, or you want to start a business or pay for a college degree.
If you have poor credit, need the money fast, or simply prefer not to use a bank, peer-to-peer lending may be an option to consider. But it’s important to be mindful that all forms of borrowing come with pros and cons to carefully consider before entering into a loan agreement.
Definition: What Is Peer-to-Peer Lending?
Peer-to-Peer Lending (P2P) is a type of borrowing where you borrow money directly from another person instead of a financial institution.
Individuals or businesses that need funding and either cannot or do not want to get it through traditional lenders like banks and credit unions may turn to peer-to-peer (P2P) lending. Some online platforms exist to help connect individuals to others who are willing to lend money out.
P2P Lending vs Traditional Loans
Both P2P lending and traditional loans give people access to extra cash, but there are significant differences between the two types of lending. The first main difference is that P2P lending comes from individual investors while traditional loans come from financial institutions like banks and credit unions.
Because of this difference, peer-to-peer lending may involve less paperwork, but also less predictable loan terms and less regulations in place to protect the borrower. Meanwhile, loans from a financial institution may involve more paperwork, but also more predictable loan terms and regulations in place to help protect the borrower.
How Does Peer-to-Peer Lending Work?
The way peer-to-peer lending generally works is a prospective borrower will apply for the loan they need on an online P2P platform. Their loan request will then be listed on the platform for investors to see. If investors decide to pick the borrower’s loan request, then the borrower may receive the funds they need through one or more investors. Then the borrower repays the amount they borrowed through monthly payments, just like any other type of loan.
- Prospective borrower applies for a loan.
- Loan request is listed for investors to see.
- If accepted, one or more investors fund the loan.
- The borrower repays the loan through monthly payments.
The main difference in how peer-to-peer lending works vs how other loans work, is that potentially several investors are involved in funding your loan, and your loan’s acceptance depends partially on individuals deciding whether or not they want to fund your loan. In this sense, regular loans may be quicker if you can qualify for a personal or installment loan.
P2P Lending Pros and Cons
Before applying for a peer-to-peer loan, it’s important to understand the benefits and drawbacks of this loan type. This can help you decide if this lending option is the best path for your financial future.
Pros of a P2P Loan
This type of loan may be a benefit to borrowers who are looking for flexible loan terms, an application process that is simple and quick, and potentially fast funding if investors decide to accept your funding request.
Flexible Terms: May offer more flexible or customizable loan terms.
Fast Funding: Can potentially provide loan funds faster if individual investors decide to approve your loan request.
Easier Application: Typically have simpler requirements, making the approval process faster and more accessible to borrowers with limited credit history.
Cons of a P2P Loan
While useful in several situations, peer-to-peer loans have disadvantages as well that are equally important to consider before making a loan decision. More flexible loan terms may be less predictable for you to plan for and your loan approval is partially dependent on individuals rather than standardized and regulated applicant requirements. Less regulations for these loans also means there are less protections in place for borrowers like you, should something go wrong with your peer-to-peer agreement.
Higher Interest Rates: Though these loans may be more accessible to borrowers with low credit, they often then come with higher interest rates to consider.
Service Fees: P2P lending platforms charge fees for using their services, on top of interest rates and fees for the loan.
Not FDIC Insured: Since these loans aren’t insured by the FDIC, this makes them a riskier proposition for the lender and often results in higher interest rates for the borrower.
Is Peer-to-Peer Lending Right for You?
If you’re a prospective borrower looking to get a loan, there are pros and cons to consider before getting a peer-to-peer loan. For some borrowers, getting a loan from a reputable lender could be a better fit with less risks. Plus, if you have a good credit history, you may qualify for lower interest rates by getting a loan through a bank or credit union.
If you’re an individual investor looking to diversify your investment portfolio, then joining a peer-to-peer lending platform as an investor might be something to consider if:
You’re Looking to Diversify Your Investments
If you’re an investor exploring how to invest in peer-to-peer lending, it's a potential alternative to traditional options like stocks or real estate. P2P loans can potentially add diversity to your portfolio and consistent cash flow, as borrowers repay loans with interest—even when other markets are down.
Traditional Loans Don't Offer What You Need
If you need to borrow money but don’t have a good enough credit score to receive financing from a traditional lender, you may still be able to get a peer-to-peer loan. It can be a fast and flexible option, especially for borrowers seeking quick funding for emergencies or opportunities.
