Peer-to-peer loans: Are they safe?

Maybe you need funds to consolidate your debts. Maybe your roof has suddenly started leaking. Or perhaps your car is making ominous noises that signal a pricey repair is likely in your future.

Whatever the reason, sometimes you simply need funds. Peer-to-peer (P2P) lending can provide a solid option for you, as it offers the opportunity for people across the financial spectrum to obtain a loan. However, there are some downsides that warrant practical consideration.

Read on to learn more about this type of lending and how P2P loans differ from traditional personal loans offered by banks, credit unions, online lenders, and other financial institutions.

Key takeaways:

• The positive: P2P loans can offer a streamlined application process, quick access to funds relative to other loans, and wider availability for people across the financial spectrum.
• The negative: P2P loans can come from sources that are less well-known, can have higher interest rates, and bring severe late penalty fees.
• Is it right for you?: Whether you’re an investor or you’re looking for funds, do your due diligence.

What are peer-to-peer lending platforms?

Peer-to-peer lending platforms provide a relatively new way for people to borrow money without going through a traditional financial institution. Instead of using a bank, you obtain funds from an individual, company, or other independent investor via a P2P lending platform.

There are, however, some similarities to banks: Lenders on these platforms set their own terms, conditions, and interest rates. But here’s the big difference between a P2P lender and a bank – P2P providers open doors for people who might not qualify for a loan at a traditional bank. Even borrowers with lower credit scores or a rocky credit history can find opportunities here.

How does peer-to-peer lending and investing work?

Consumers interested in peer-to-peer loans typically find lenders through online platforms, such as LendingClub, Upstart, and Prosper. These sites make it easy for borrowers to choose offers that fit their goals and budget, while investors weigh the risk of each applicant and decide whether they’re comfortable funding the loan.

Peer-to-peer lending for borrowers

P2P loans offer a straightforward application experience, but prequalification is essential – it gives borrowers clarity on their borrowing limit as well as the interest rate they can expect. Here are the steps of the P2P borrowing process:

• Get prequalified, which entails a soft pull on your credit report (note how this differs from a hard credit inquiry)
• Complete a loan application
• Receive loan approval – note that approval times may vary
• Obtain the loan funds
• Begin making installment payments on the loan

Peer-to-peer lending for investors

Peer-to-peer lending also appeals to investors who sign up as lenders on the platforms, as they can decide which loans they wish to fund. They can also establish the terms, conditions, and rates associated with their loan offer.

Many P2P platforms allow investors to choose “auto fund” settings, which automatically positions the investor as a lender for specific types of loans, like home improvement or education loans. Some platforms also allow investors to assess risk factors for loans, and they can also choose to fund only a portion of a loan — thereby sharing financial risk with other investors.

P2P personal loans vs. traditional personal loans

To be clear, P2P loans are considered personal loans. However, P2P personal loans and conventional (or traditional) personal loans differ in several ways related to their structure and repayment terms.

As with all important finance decisions, it pays to read the fine print and learn the details and fees associated with personal loans — for instance, P2P lending platforms may impose steep fees for late payments.

The table below highlights the key differences between traditional personal loans and P2P personal loans.

Reasons for seeking peer-to-peer lending

A primary attraction of P2P loans is that they can work for borrowers with low credit scores who may not qualify for traditional loans. If you are considering taking out a P2P loan, though, remember they are unsecured – meaning that they do not require the borrower to provide collateral to the lender to back the value of the loan. That can appeal to some borrowers because it simplifies the process and provides an option for borrowers who don’t want to tie up their assets.

P2P loans for debt consolidation

For some, P2P loans can be a practical way to consolidate high-interest debt, like credit cards, payday loans, or car title loans. As noted in the chart above, however, P2P loans can also have high interest rates. So be careful when you consider these loans, do your research, and shop around for the best rate.

Home improvement peer-to-peer loans

Some homeowners may use P2P lending to pay for home improvement projects. These loans can be an appealing option for borrowers who do not have enough equity in their home to qualify for a home equity loan.

Peer-to-peer business lending

The P2P model also applies to aspiring small business owners, who may need funding for supplies, marketing, and other essentials. While there are many small-business loans available, a P2P loan can be a convenient way to acquire necessary funds for startup because it connects entrepreneurs directly with supportive investors – often with faster approval and more flexible terms than some traditional lending options.

Peer-to-peer lending risks

Peer-to-peer lending offers several benefits for borrowers, but it comes with some risks, as well. Because this type of lending is not affiliated with a financial institution, bank, or credit union, for instance, borrowers do not always know the reputation of their lender.

Lenders (or investors who serve as the lenders) face risks, too – while the loans might earn attractive returns, there’s also the possibility that the borrower could default. Unlike banks and financial institutions, P2P investors are not insured and lend at their own risk.

Pros and cons of peer-to-peer lending

This chart spells out the pluses and minuses that come with P2P lending:

Alternative loan options

Because of the variables that come with P2P lending, some borrowers may not feel comfortable with peer-to-peer lenders and would prefer more conventional loans or financial solutions. Their options include:

Personal loans

Personal loans are essentially installment loans that can be used for a variety of needs, and the most popular uses include debt consolidation and home improvement loans. More traditional financial institutions, such as banks or credit unions, may provide advantages for borrowers, such as more personalized customer service or lower rates (although creditworthiness is still critical).

Note that Rocket Loans^SM offers personal loans, and our benefits can include same-day funding.

0% APR credit cards

Another loan option is to take out a 0% annual percentage rate (APR) credit card, an offer that credit card companies and financial institutions extend to individuals with good credit. During the promotional period (which typically extends from 12 to 18 months, cardholders do not accrue interest charges on purchases – or, in some cases, on balance transfers.

This can be a solid opportunity for someone needing funding – If you make a sound financial plan, you can pay off the card balance before the promotional period expires and save a solid amount of money on interest fees. In other words: used correctly, these cards serve as an interest-free loan.

That benefit disappears, however, if you maintain a balance after the promotional period expires. Interest charges on your balance can lead to expensive monthly payments and a higher total cost of borrowing.

Family loans

If these options don’t quite work, consider looking into a loan extended by a family member. The terms could be more flexible – some family members may charge interest, for instance, while others don’t.

But there should be no doubt: this would be an actual loan, and you should strongly consider writing a contract that details the loan terms and conditions. Borrowing money from a family member could put a strain on the relationship, and you’ll want to treat this as seriously as you would a “real” loan from a P2P lender or financial institution.

The bottom line: Understand the risks of P2P personal loans

P2P lending platforms can provide needed funds when you need them, but they also come with some drawbacks. On the plus side, these loans offer an opportunity for people with lower credit scores to obtain money, but borrowers may not know the origin of their funds, and P2P loans may also carry higher interest rates and steep late fees.

So, look closely into this option, and be sure you’re making an informed decision that aligns with your specific situation and long-term financial goals. With careful planning, P2P lending could provide the funds you need to take the next step in your life – or keep your car running smoothly.

Keep in mind that Rocket Loans offers personal loans, and we’re always here to help you improve your financial future.

This article is for informational purposes only and is not intended to provide, and should not be relied on for, medical, legal, financial, or tax advice. You should consult with a qualified professional for advice specific to your situation. Consumers should independently verify that any services, products, or programs referenced meet their needs and comply with applicable requirements.

Same Day Funding available for clients completing the loan process and signing the Promissory Note by 4:00PM 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 which may occur due to incorrect routing number, account number, or errors of your financial institution.