The Pros (and a Few Cons) of Peer-to-Peer Lending

Photo:  Cast Of Thousands (Shutterstock)
Photo: Cast Of Thousands (Shutterstock)

Everyone has moments in their life when they need a lump sum of money right away—when they don’t have the time to make a savings plan and wait until they’ve accumulated the needed funds. Borrowing money can be either a lengthy process full of paperwork, delays, and credit checks—or it can be fast and easy, like with credit cards and cash advances, but which also come with high interest rates.

And that’s if you can even get a traditional loan or credit line. In those circumstances, many people turn to personal loans from friends and families, but that’s also a way to potentially damage relationships. Or some desperate folks might head for a payday lender, which is a monumentally bad idea. But there’s another option that might work for you: Peer-to-peer (P2P) lending.

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What it peer-to-peer lending?

Peer-to-peer lending involves borrowing money from one or more private investors instead of a bank or other organization. It’s a kind of crowd-funded personal loan—instead of borrowing, say, $5,000 from a bank, a payday lender or your uncle, you’re borrowing it from strangers. Usually this involves a platform like Prosper or Funding Circle, where investors choose the loans they want to fund.

Typically, loans are funded by several investors at once, but the borrower makes a single monthly payment that is then split among the funders. They make money from charging interest, and you get your short-term financial needs met without dealing with a bank or other financial institution.

How P2P loans work

Getting a P2P loan is a pretty straightforward process, but the specific steps vary by platform:

  1. Identify the right platform. Different platforms offer different rates and have different minimum and maximum amounts you can borrow (typically these max out at about $40,000 to $50,000).

  2. Fill out a preliminary application. This is similar to any loan application, and will ask you why you want the money and to provide some personal information, like pay stubs and tax records, to demonstrate your proof of income.

  3. The platform will run your credit score and review your application. Based on this information, you’ll be assigned a rating, which investors will use to decide if they want to loan you money and at what terms.

  4. Review offers. One or more investors may be willing to fund all or part of your loan. You’ll have the chance to look over the terms being offered and decide if you want to proceed with one. If your loan is given final approval, you receive your funds and the repayment schedule begins.

Keep in mind that most of these loans will charge you an origination fee just like a traditional loan. Typically these fees are about 5% (again, this varies) and it typically comes out of the loaned amount. In other words, if you borrow $5,000 the platform will only deposit $4,750 into your account, with the rest taken as a fee. That means you might need to adjust how much you’re borrowing to ensure you get the amount you actually need.

Why P2P?

There are a lot of reasons you might find a P2P loan an attractive option:

  • Convenience. P2P loans are typically entirely online affairs, so you don’t have to show up at a bank or credit union in order to sit and stare at a loan officer as they frown at a computer screen. You complete the application online, upload documents, and review your options entirely over the internet.

  • Easier approvals. If you’ve been denied a more traditional loan because your credit score and history are sketchy, you might have more luck with a P2P platform. Investors can set their own level of acceptable risk for their money; if there are enough investors on the platform who don’t mind your financial mess too much, you’ll get that loan.

  • Better terms. There is no guarantee, but you can often get better loan terms through P2P platforms. Interest rates can be lower than the standard rates offered at banks because investors are pooling smaller amounts of money individually, and can tolerate lower rates of return.

It’s important to note there are some potential disadvantages to P2P loans, as well:

  • Higher fees. P2P loans aren’t automatically better than bank loans or other traditional loans. They can be structured in different ways, and you might wind up paying more in fees for your loan than you would at a bank—so pay close attention.

  • Less service. Banks and credit unions typically have entire departments devoted to servicing loans, and if you run into trouble paying your loan back, you can often get a surprising amount of assistance, because the bank would prefer making arrangements to going into collections or default. A P2P lender is decentralized, which can mean less support—and getting slapped into collections much more quickly.

Scams

Like everything else on the internet, the P2P ecosystem is rife with scammers who take advantage of desperate folks. For lenders, the risk is waking up one day to discover a platform has shut down and absconded with the money they invested. For borrowers, the risk is more about phishing—getting your personal and financial information in order to set up fraudulent accounts. You sign up with a P2P platform hoping to get a small loan, and instead, your identity is stolen.

There are some basic ways to avoid this fate:

  • Due diligence. Start by researching the various P2P lending platforms, and avoid any that have bad reviews—or no reviews at all. Avoid P2P platforms that are less than three years old—most of the problematic P2P lenders fail and shut down within a year or two.

  • Licensing. P2P lending platforms are regulated by the government, and must hold applicable licenses in the state or nation in which they operate. Check to make sure the platform you’re considering is properly licensed, and be wary of P2P lenders operating out of countries that don’t have the greatest record of financial regulation.

  • Displaced accounts. Check to see where the platform does its own banking. If the platform has its offices in the U.S. but banks through Venezuela, for example, that’s a red flag.

  • Clear communication. Scam platforms often fail to provide you with the written loan contract—you should be able to review the terms of the loan you’re agreeing to before you commit.

Borrowing money from a peer-to-peer lender can be a good option if you’re having trouble borrowing money in more traditional ways. The key is to ensure you are actually getting a better deal—the paperwork and effort of a traditional loan might be well worth it if you get a better rate from a more reliable lender.

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