Peer-to-Peer lending has come on strong in the past few years, and not coincidentally since the financial meltdown. That was the time of the banks decided that they weren’t going to lend to anybody. That opened up an opportunity for the free market to find another way for people to borrow money. And that's when the peer-to-peer phenomenon started getting popular.
There are a lot of reasons why P2P lending has grown so quickly. But is it a good loan source for you? Learn more here on getting a loan during your decision making process.
What Is Peer-to-Peer Lending?
Peer-to-peer lending can loosely be thought of as non-bank banking. That is, it's a process of lending and borrowing that takes place without the use of traditional banks. And for that reason, it looks a whole lot different than conventional banking.
Peer-to-peer lending is mostly an online activity. Borrowers come to the various peer-to-peer lending websites looking for loans – and better terms than what they can get through their local bank – while investors come looking to lend money at much higher rates of return than what they can get at a bank.
On the surface, it may seem as if the higher rates paid to peer-to-peer lending investors would result in higher loan rates for borrowers, but that's not generally the case.
Peer-to-peer lending brings borrowers and investors together on the same websites. Commonly known as “P2P”, it's an arrangement that “cuts out the middleman”, more commonly known as the banker.
Here's the thing, it costs money to operate a bank. You need a physical bank branch that has to be purchased and maintained. You also have to staff the operation with employees, and that requires paying multiple salaries, as well as related employee benefits. Then there's the acquisition and maintenance of costly equipment, such as in-house computer systems and software, as well as sophisticated security equipment.
Now multiply the costs of that single bank branch by multiple branches, and you start to get an idea why you might pay 15% for a loan at the same bank where you will earn less than a 1% return on funds held on deposit there. It’s not exactly an equitable – or democratic – financial arrangement.
P2P lending doesn't have all that bank branch real estate, hundreds or thousands of employees, or expensive equipment. And for that reason, you might see an arrangement that looks more like 10% loan rates, and 8% returns on your investment money.
Lending Sites in the US
Though the entire concept of peer to peer lending started in the Third World decades ago, there are now dozens of P2P platforms operating in the US. Most people have heard of Prosper and Lending club, but there are several other lenders in the U.S. Market.
Some of the more common peer to peer lending sites include:
- Lending Club, which has grown to become the largest P2P lender in the country
- Prosper, which was the first P2P platform
- Funding Circle
- SoFi, which specializes in student loans and student loan refinances
These are just a handful of the growing number of peer-to-peer companies in the United States.
Why Would Anyone Invest through a P2P Lending Platform?
Higher returns on investment are a powerful motivator. This is especially true since interest rates on completely safe, short-term instruments like money market funds and certificates of deposit are commonly paying less than 1% per year. And even if you want to invest in longer-term securities to get higher returns, they're not there either. For example, the 10 Year US Treasury note currently pays only 1.82% per year. That's an incredibly low return considering that you will have to tie your money up for a full decade just to get it.
By contrast, an investor can easily get a return in the neighborhood of 10% per year on a portfolio of five-year loan notes, with blended credit profiles, by investing his or her money through a peer-to-peer platform.
Yes, there's more risk involved in investing/lending through a P2P platform – after all, there's no FDIC insurance on your money. But the rate is much higher than what it is on conventional fixed income instruments, as well as the fact that a P2P investor can create his own portfolio to match his own risk tolerance.
For this reason, peer-to-peer lending platforms tend to have plenty of investor money to lend out. And if you’re a borrower, that’s a win for you.
Why Would a Borrower Use P2P?
If investing through peer-to-peer sites makes good sense for investors, there are probably even more reasons why a borrower would want to get a loan from one.
Here are just a few of them:
- Interest rates – Depending on the type of loan taken, rates are often lower on P2P sites than what you can get through a bank. This is especially true when you compare P2P rates with those that you will pay for credit cards and business loans. It gets back to P2P platforms having a lower cost of doing business than the banks. They’re not lower in all cases, but they’re always worth a try on just about any loan type you want to take.
- Credit profile – P2P platforms are not subprime lenders, but they will often make loans that banks won't. You'll be charged higher interest if you have credit blemishes, but that may be preferable to not being able to get a loan at all.
- Loan purpose – P2P platforms are a lot less restrictive when it comes to the purpose of your loan. One example is business loans. A P2P lender might make you a personal loan for business purposes, while a bank may not want to make a business loan at all, under any guise.
- Ease of application – The entire loan process is handled online, so you never have to leave your house. Even third-party verification and document signing can usually be done online. All you need to do is scan them, then either email them, or download them to a portal on the P2P site.
- Speed – You can often handle the entire loan process, from application to receipt of funds, in little as two or three days. By contrast, certain bank loans can take weeks or even months to drag out.
- No face-to-face meetings – Some people feel uncomfortable when applying for a loan requires a face-to-face meeting, particularly at a bank. Such meetings can often have the feel of a physical exam, and include requests by bank personnel for information and documents that make you feel uncomfortable. There are no face-to-face meetings when you apply for a loan through a peer-to-peer website.
- Your loan application is processed anonymously – Investors will see your loan request, but you won't be personally identified in the process. There’s little danger that a neighbor who works at at bank will have access to your loan information, since a P2P is not a bank..
When you consider all of those advantages, it’s easy enough to see why people are increasingly choosing peer-to-peer sources over the local bank.
How It Works
Each peer-to-peer lender works a little bit differently from the others, but there are some common steps to the loan application process.
It generally goes something like this:
- You complete a brief questionnaire, the platform does a “soft credit pull”, and you're assigned a loan grade (we'll get deeper into these with individual P2P reviews).
- Your loan inquiry will be made available to investors, who will review the loan request and determine if they want to invest at the assigned loan rate (which based on the loan grade).
- When enough investor interest is shown in your loan, your loan will then be eligible to be funded.
- You will then be required to furnish certain documentation, such as proof of income and employment, and a list of existing debts that you intend to repay with the new loan (refinances and debt consolidation loans are very common with P2P platforms).
- The loan is then underwritten to make sure that the documentation supports your claims in the initial questionnaire; the package will either be approved for funding, or there will be a request for additional documentation.
- Once fully approved, the loan documents will be prepared, and sent to you for signature.
- Funds are typically wired to your bank account within 24 to 48 hours of the receipt of your signed documents by the peer-to-peer platform
Though the process may seem as if it takes several weeks, it will actually proceed very quickly if you are prepared to immediately furnish any and all required documentation. Since you can usually scan and email information, the entire application process can be compacted down to just a few days.
Loan amounts granted are typically anywhere between $2,000 and $35,000, though many platforms will lend higher amounts for various purposes – all the way up to well over $100,000 depending on the loan purpose. You will usually be required to have a credit score in the mid-600s or higher in order to qualify, though loans for those with impaired credit are becoming more common. And loans typically run between three years and five years, but once again there is significant flexibility for different loan types and from different lending platforms.
P2P platforms usually don't charge application fees, or any of the various fees that are generally charged by banks in connection with loans. But one fee with peer-to-peer loans that you will need to be aware of is that they generally charge origination fees. They can represent anywhere from 1% to 5% of the loan amount provided, and are usually deducted from the loan proceeds. So if you are approved for a $10,000 loan with a 2% origination fee, $200 will be deducted from the amount of the loan proceeds that you will receive.
The actual amount of the origination fee is closely tied to your loan grade, which is largely (but not entirely) determined by your credit profile. Other factors include the term of the loan, the purpose, the loan amount and your income or employment.
Types of Peer-to-Peer Loans Available
As the number of peer-to-peer lenders has expanded, so have the types of loans that are available through them.
Common loan types available include:
- Personal loans
- Auto loans
- Business loans
- Student loans (including student loan refinances)
- Bad debt loans
- Medical loans (for uncovered medical expenses)
Not all peer-to-peer lenders do all of these loans, in fact a single platform typically specializes in just one or two loan types. But never assume that a certain kind of loan is not available through a peer-to-peer platform somewhere; new sites are coming up all the time, and some are moving into previously unexplored territory.
Investing Software Services
As interest in investing through peer-to-peer sites becomes more popular, there is growing demand for software services that can help investors select specific loans – or notes – that they want to invest in. These software services help with the construction, management, custody, and reporting requirements for a portfolio of peer-to-peer loans.
An example of such a provider is NSR Invest, who entered the P2P investing software services market last year.
NSR Invest is a managed account investment platform that provides P2P investment tools to financial advisors. They launched a new generation of software that is enabling financial advisors to establish and manage separate investment accounts specifically through Lending Club. And though the specific software is new, NSR Invest has actually been working with Lending Club since 2011, and also has ongoing relationships with Prosper Marketplace and Funding Circle.
NSR Invest is hardly alone, even though the industry is new. Some of the more prominent peer-to-peer investing software services include:
- Lending Robot
- Peer Trader
Each of these firms are actively working to improve the investment experience on P2P platforms. And as they do, the lending process itself will become increasingly streamlined and more efficient.
Despite the fact that peer-to-peer lending has been happening in the US for only a few years, the practice is growing rapidly. As general participation increases, along with the various loan types the industry will serve, peer-to-peer lenders will provide serious competition for banks when it comes to lending.
But the future is already here, since hundreds of thousands of people have already taken loans through the many peer-to-peer lending platforms that are up and running. Have you tried to use one yet, either as an investor or a borrower?