Peer-To-Peer (P2P) Lending: Is It A Safe Investment?
6 minute read July 28, 2022
Today’s financing options are numerous, and some don’t even involve traditional financial institutions like banks or lenders. Peer-to-peer lending is a relatively new financing option that connects borrowers with investors willing to provide funding for a return on their investment.
Let’s take a closer look at how peer-to-peer lending works, the risks involved in peer loans, and alternative lending options to possibly consider.
What Is Peer-To-Peer Lending?
Peer-to-peer lending, often known as simply P2P lending, is a financing system that allows borrowers to take out loans directly from individuals or companies offering loans online. Peer-to-peer loan transactions primarily occur on P2P lending sites that arrange the rates and terms for the transactions.
By not working through traditional banks, credit unions or lenders, peer-to-peer lending can allow borrowers with lower credit scores and fewer financing options to get loans at potentially lower rates than they could otherwise qualify for. By essentially “cutting out the middleman,” peer lenders can also earn a direct return on their investments.
How Does Peer-To-Peer Lending And Investing Work?
Peer-to-peer lending takes place almost entirely online through P2P lending platforms, such as LendingClub, Prosper Marketplace and Upstart. The application and approval processes are often straightforward with quick turnaround, though features may differ between lending platforms.
Lenders and prospective borrowers can choose the lending platform they want, create personal accounts and from there begin their respective processes. Up next, we’ll break down the different processes for each.
- Get prequalified. Getting prequalified through your P2P platform of choice informs you of the interest rates and loan terms you’re likely eligible for based on your credit score. This is often determined through a soft credit check. Once you review and approve these rates and terms, you can move on to the full application.
- Fill out an application. Complete and submit a full application for the loan amount you want. Another credit check will be required, this one a hard inquiry that’ll likely impact your credit score.
- Wait on approval and funding. If your loan is approved, it’ll move into the funding stage where multiple investors on the site can review your loan request and decide whether to finance. Multiple lenders can sometimes finance a loan at once, each funding a portion of the requested loan amount.
- Receive your funds. If one or more lenders accept your request, they can electronically transfer the funds directly into your bank account. Approval and disbursal can take a week or more, or as little as 1 business day.
- Start making payments. Once you’ve been funded, you’ll start paying the loan back in monthly installment payments, plus interest. If you have multiple financers, your payments will be split proportionately between them.
Peer-to-peer lending is slightly simpler if you’re the one doing the lending. Once you have an account with a P2P lending platform, you can review various loan requests and decide if you’d like to fund them, whether it be for a portion or the full loan amount.
Certain platforms include features that help you grade the risk factors for certain loans. You can also opt for auto investing, where the platform automatically finances certain loans on your behalf.
You can track your loan repayment and earnings through your personal account.
Reasons For Peer-To-Peer Lending
You can use P2P loans for just about anything; they’re essentially the same as unsecured personal loans. Below are some of the more common reasons to pursue peer-to-peer lending:
Debt consolidation is a debt management tactic that combines all of your debt under a single monthly payment. For many debtors, having only one payment and interest rate to worry about makes paying off multiple debts seem easier.
Home improvements can be expensive but rewarding for your home and its value. If you’re unable to get a home improvement loan through a traditional financial institution, you could utilize peer-to-peer lending to potentially find backers.
Peer-To-Peer Business Lending
With a small-business loan, an entrepreneur or small-business owner can get the funding they need to start or expand their small business. They can use a P2P loan to purchase equipment or fulfill other business needs.
Risks When You Borrow Or Lend Peer-To-Peer
For borrowers, peer-to-peer lending is relatively safe. P2P sites can protect personal and financial information as securely as a traditional lender. However, with traditional lending, borrowers know their money is coming from a trusted source. With peer-to-peer lenders, you could have no idea who you’re borrowing from or where the money’s coming from.
On the lending side, while there’s an opportunity to earn a profit by investing in peer-to-peer lending, investors take on a big risk. For example, investing in a borrower with a lower credit score could yield higher returns for the lender – because of the higher interest rate – but with that comes a higher probability of a loan default. Peer lenders aren’t insured like traditional banks and financial institutions, and they likely won’t get their money back in the event of a default.
Pros And Cons Of Peer-To-Peer Lending
Now that we know more about how peer-to-peer lending works, let’s explore the benefits and drawbacks of this lending option:
- Peer-to peer lending can offer lower interest rates because of fewer overhead costs being involved.
- Lower credit scores can still qualify for some loans.
- Making an account on a P2P platform and applying online are typically straightforward and easy processes.
- Investing in P2P loans can help to diversify an investment portfolio.
- Low credit scores can still yield higher interest rates.
- Your loan may not get funded if no lenders choose to finance it.
- Some peer-to-peer lenders and platforms still charge borrowers origination fees and other costs.
- You may not know where your funding is coming from.
- Investors may not get their money back if a borrower defaults.
Alternative Loan Options
Peer-to-peer lending is a bit of a gamble no matter which side of the lending you’re on, and more traditional lending might feel safer for some people.
Consider these alternative financing options:
A personal loan is an unsecured installment loan that’s usable for nearly any purpose. When you apply for a personal loan, your credit score helps determine your interest rate and loan terms. A higher score means possibly lower rates.
You can get a personal loan through P2P lending or a traditional bank or lender, and the processes are typically similar. However, if you already have an account with a bank or lender, you may be able to negotiate rates and terms better than you could with peer-to-peer lending.
If time is of the essence and you believe peer-to-peer lending can fund you faster, consider that some lending platforms, like Rocket Loans℠, can offer same-day funding for certain borrowers.*
0% APR Credit Cards
Credit cards tend to have higher interest rates than personal loans, but some card issuers offer an introductory period for new cards with a 0% annual percentage rate (APR). For a period of 12 – 18 months, cardholders can make interest-free card payments on their balances. If you can pay off your balance in that time, you can save on interest payments. If not, you could incur high interest rates on the amount you’ve left.
Borrowing From Friends Or Family
When you can borrow from people you know, you can possibly bypass high interest rates, credit checks and repayment schedules. If necessary, you can still draw up a contract with your friend or family member just to assure them you’ll repay them. The terms of the loan are left entirely up to those involved.
Peer-to-peer lending can simplify the lending process by working around traditional banks and lenders, but knowing where your money is coming from can count for a lot. Borrowers may find easier access to funding, and investors stand to earn a profit by funding certain loans, but the risks of peer-to-peer lending for both parties could steer some people toward a more traditional financing route.
To see the personal loan rates you’re eligible for, get prequalified with Rocket Loans today.
*Same day funding is available for clients completing the loan process and signing the Promissory Note by 1:00 p.m. ET on a business day. Also note, the ACH credit will be submitted to your bank the same business day. This may result in same day funding, but results may vary, and your bank may have rules that limit our ability to credit your account. We are not responsible for delays that may occur due to an incorrect routing number, an incorrect account number or errors of your financial institution.