Peer-to-peer lending has come on strong since the financial meltdown – and not by coincidence. That was about the time that banks decided they weren’t lending to anybody. The decision opened up an opportunity for the free market to provide 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 as part of your decision making process.
The complete guide on peer-to-peer lending:
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 U.S.
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:
Started in 2007, Lending Club has since grown to become the largest peer-to-peer lending platform on the web. By the end of 2015, the site funded nearly $16 billion worth of loans, including more than $2.5 billion in the last quarter of the year. Obviously Lending Club is doing a bunch of things right.
As a peer-to-peer lending platform, Lending Club is a site that brings investors and borrowers together to put together loans that will benefit both parties. The entire application process takes place on the website, and can be completed in a matter of minutes. And after you apply for a loan, the site enables you to link up to Credit Karma where you can begin monitoring your credit.
That last point can be important. Since so many of the loans arranged on Lending Club involve debt consolidation, borrowers often see an increase in their credit scores shortly after initiating the loan. The reason for this increase is the fact that the borrowers credit card debt utilization ratio declines after several credit cards have been consolidated into a single loan on the platform.
As a general rule, Lending Club makes personal loans of up to $35,000. Loans are fixed rate and unsecured. Terms range from 24 months to 60 months, after which your debt is fully paid. Interest rates range from 5.24% APR to a high of 31.70% APR, which is determined by your credit grade.
Credit grades are determined by your credit score and credit profile, as well as by your income, and both the amount and term of the loan.
The platform also charges an origination fee of between 1% and 5% of the loan amount that you are borrowing. These origination fees are not unusual in the personal loans space, and can still result in APRs that are much lower than those charged by credit cards. However, there are no application fees, and no prepayment penalties.
Though Lending Club is best known for personal loans, they also make business loans and medical loans (under their “Patients Solutions” plan) that can be used for medical procedures that are not covered by health insurance, such as fertility treatments and hair transplants.
To get more information about this industry leading company see more in our in depth Lending Club review.
Founded in 2005, Prosper is the first among the popular peer 2 peer lending sites. The site has more than 2 million members and has funded more than $5 billion in loans to date. The platform works in a fashion similar to Lending Club, but not identical.
Like Lending Club, Prosper brings individual investors and borrowers together on the same website. Some of those investors are large concerns, such as Sequoia Capital, BlackRock, Institutional Venture Partners, and Credit Suisse NEXT Fund. This institutional participation is important in itself; as peer-to-peer lending is rapidly growing, large, institutional investors are becoming more actively involved on the funding side.
Prosper makes personal loans for amounts of between $2,000 and $35,000. Proceeds of the loan can be used for just about any purpose, including debt consolidation, home improvement, business purposes, auto loans, and short-term and bridge loans. You can also borrow money to adopt a child, purchase an engagement ring, or take out “green loans”, which enable you to finance systems that are based on renewable energy.
Loan terms range from 36 months to 60 months, with interest rates between 5.99% APR and 36.00% APR. Your loan rate is calculated on the basis of your Prosper Rating, which is similar to Lending Club's credit grade, and is based on your credit score and credit profile, loan term and loan amount.
Loans are fixed rate installment loans, which means that the debt will be fully paid by the end of the loan term. There are no prepayment penalties, and no hidden fees, though Prosper does charge origination fees similar to Lending Club.
Once again, the entire process takes place online where you can complete an application in minutes, and get your Prosper Rating. From that point, your interest rate will be determined , and your loan profile will be made available to prospective investors who will decide to fund the loan. Since funding is done in small increments from multiple investors, the loan will not fully fund until there is sufficient interest from enough investors. But that process could happen is little as a one or two days.
Learn more about the oldest of the P2P companies in the united States in our full Prosper review.
PeerStreet is taking what Lending Club and Prosper did for personal loans and applying it to real estate. Founded in 2013, Peerstreet has expanded rapidly and their private marketplace is very easy to use.
Unlike other companies that are funneling their investors into REITs, PeerStreet allows investors to invest directly in real estate loans. The loans are not your typical 30 year mortgages but short term loans (6-24 months). The loans are for special situations like rehabilitation of a property that a landlord wishes to rent out.
The annual returns for the average investor work out to be between 6-12% and you can get started investing with as little as $1,000.
PeerStreet also does all their own underwriting on the properties and evaluate all their loan originators.
The one downside to PeerStreet is that you must be an accredited investor to participate in their marketplace. This pretty much eliminates most small investors from having a shot at this unique P2P lender.
Funding Circle is a peer-to-peer lending site for people who are looking for a business loan. This is important, because the small business market is completely underserved by the banking industry. Not only do banks typically have extensive requirements before they will make a loan to a small business, but they also have a preference for lending to larger businesses that are better established. The small, one man or woman shop is often left out in the cold when it comes to getting business financing.
The platform has made more than $2 billion in loans to more than 12,000 small businesses around the world.
With Funding Circle, you can borrow as little as $25,000, to as much as $500,000 on a business loan at rates that start as low as 5.49% (the range is between 5.49% and 20.99%). Loan terms are fixed rate, and range from one year to five years. And of course, Funding Circle also has an origination fee, that is typically 4.99% of the loan amount you are borrowing.
You can borrow money for a variety of business purposes, including refinancing existing debt, buying inventory or equipment, moving or expanding your operating space, or even to hiring more employees.
One of the best features of Funding Circle is that you only need to be in business for as little as six months to three years.The application process takes as little as 10 minutes, and you can receive funding within 10 days. The entire process takes place online, and you will be assigned your own account manager to help guide you through the process. Learn more about their small business loans and investing in our Funding Circle reviews.
A recent newcomer to the list of peer to peer sites, Upstart began operations in 2014, but has already funded more than $300 million in loans. Among the major peer-to-peer lenders, Upstart has the most in common with SoFi. Like SoFi, Upstart takes a closer look at non-traditional underwriting criteria, preferring to look at a borrower's potential, which includes consideration of the school you attended, the area of study, your academic performance, and your work history.
They do take more traditional lending criteria like credit and income into consideration. The primary focus is on looking to identify what they refer to as “future prime” borrowers. Those are borrowers who are early in life, but are showing signs of having strong future potential. For this reason, the platform carefully evaluates factors that contribute to future financial stability, and makes loans accordingly.
For example, Upstart reports that the average borrower on the platform has a FICO score of 691, an average income of $106,182, is 91% likely to be a college graduate, and 76% likely to be refinancing credit cards. The last point is important – borrowers who refinance credit cards are typically improving their financial standing almost immediately as a result of lowering their interest rates, reducing their monthly payment, and converting revolving debt into an installment loan.
Loan amounts range from $3,000-$35,000, with terms of from three years to five years , and have no prepayment penalty. The site claims that their rates are 30% lower than those of other lenders on average. Upstart reports that rates average 15% on a three-year loan, though they can range from 4.00% to 26.06% for three year loans, and between 6.00% and 27.32% for five year loans. Like the other peer-to-peer lenders, Upstart also charges an origination fee, which can range between 1% and 6% of the loan. See the full details in our Upstart Loans Review.
PeerForm is a peer-to-peer lending platform that was founded in 2010, and makes loans to both individuals and small businesses. The site is somewhat more tolerant on credit scores in that they will lend to borrowers with scores as low as 600 (most others require a score in the mid-600s or better).
Much like the other peer-to-peer platforms, you start by completing a simple online application, that takes no more than a few minutes. You select the type of loan that you want, as well as the amount, and then your request is put into a loan listing on the site. That is where investors decide to fund your loan (the process can take anywhere from one day up to two weeks). Once they do, the information you provided in your application is verified, and the funding process begins.
Interest rates range from a low of 6.44% to a high of 29.99%, and require an origination fee of between 1% and 5% of the loan amount. However, there are no application fees and no prepayment penalties. The loans are unsecured, and require no collateral.
You can borrow money for a wide range of purposes, including debt consolidation, a wedding loan, home improvement, medical expenses, moving and relocation, car financing and more. Loan amounts range between $1,000 and $25,000, and all loans are for a term of three years. Get all the details on this great company in our Peerform reviews for investors and borrowers.
SoFi, which is short for Social Finance, has become one of the leading sources for student loan refinances available anywhere. This site is virtually synonymous with student loans, though they also provide mortgages and personal loans.
The platform was founded by people who are close to the college scene, and well acquainted with the nuances of student loan refinances. That is an area of finance that is not adequately served by the banking industry. There are just a few major lenders who will provide student loan refinances, and SoFi is one of them.
SoFi is a peer-to-peer lending platform where student loan refinances are granted largely on the basis of non-traditional criteria, such as type of occupation, the college or university you graduated from, your GPA, and your major – as well as your income and credit profile. But this means that loan approval is not strictly based on income or credit. The education related criteria weigh heavily in the decision.
This is important because while student loans are granted on a virtually automatic basis, student loan refinances require that you qualify based on your ability to repay. SoFi considers your educational background as part of the evidence that you can repay.
Also, as a peer-to-peer lender, SoFi is available seven days a week, and you can complete the entire application process online. The site claims that the typical member can save an average of $14,000 as a result of refinancing a student loan with them.
SoFi currently has rates on student loan refinances that range from 3.50% APR to 7.49% APR on fixed rate loans, and between 2.13% APR and 5.68% APR on variable rate loans. You can also refinance the entire amount of student loan debt that you currently have, as the platform does not indicate any maximum loan amount.
You can refinance both private student loans and federal student loans, though the site recommends that you be careful in refinancing federal loans. This is because federal loans come with certain protections that are not available with private source loans, nor with SoFi refinances. You have to appreciate that kind of openness and honesty in a lender of any stripe!
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 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.