Today, everyone takes loans to fulfill financial needs. While some choose to go through banks and other institutions, some prefer peer-to-peer (P2P) lenders. P2P lending allows you to acquire loans directly from other individuals. So, there is no involvement of financial institutions. Also, the platforms that enable P2P lending propose it as an alternative financing method. This kind of lending is also known as crowdlending or social lending and has been around since 2005.
P2P lending – What it means
In P2P lending, there is no mediator, and the portals that offer this scheme aim to connect the borrowers and investors directly. Every website will set the terms and rates and allow the transaction. Typically, the websites have an array of interest rates that depends on the applicant’s creditworthiness.
So, to venture into peer-to-peer lending, the investor will first have to open an account with the website. After that, a sum of money needs to be deposited, which will be dispersed as a loan. Now, the loan applicant will update their financial profile, and there will be a risk category assigned to it, which will decide the interest rate that the applicant will have to bear. Following this, the loan applicant can carefully review the offer and determine if they want to accept it or not. All the monthly payments and the money transfers are handled directly via the platform. This process can be completely automated, or the borrowers and the lenders can correspond.
Pros and cons of peer-to-peer loans
There are both pros and cons associated with P2P lending for both lenders and borrowers. Here, we will address them.
- Higher return to the investors
P2P lending will offer a high return to the investors compared to the other kinds of investments.
- Greater accessibility
P2P loans are indeed one of the most accessible funding sources for borrowers compared to conventional loans taken from any other financial institution. Some borrowers might have a hard time getting their loan requests approved due to poor credit ratings, or they may want a loan for any atypical purpose. In such cases, the P2P loan can be a better pick.
- Low rates of interest
In P2P loans, the interest rate is usually less, as there is high competition between the low origination fee and the lenders.
- Credit risk
There is a greater degree of credit risk involved in peer-to-peer loans. Typically, borrowers who will opt for such loans have low credit ratings, which does not allow them to acquire a conventional loan from the bank. Thus, the lender must be aware of the possible default of the counterparty.
- No protection
The government will not offer any protection or insurance to the lenders on these loans. So, if there is a default, there is no protection.
Some jurisdictions do not allow P2P loans or require the companies that offer these services to adhere to the investment regulation. Hence, P2P lending might not be available for some lenders or borrowers.
Fee charged by the P2P lenders
Broadly, the most prevalent kind of fee that you may see in peer-to-peer lenders is the origination fee. This is usually 8% of the amount of loan. The lender will either take this amount out of your loan or charge it upfront. Also, if you miss any re-payment dates, you will have to bear a late fee. There may be other fees involved as well, but this will depend on the lender you choose to work with. Thus, before you opt for any P2P loan, you must understand all the fees that you may be liable to pay.
What can you use your P2P loan for?
In a nutshell, P2P loans are like any other unsecured personal loan. Hence, just like any other personal loan, you can use these loans for all kinds of legal purposes, such as:
- Debt consolidation
- Home improvement
- Fertility treatment
- Starting or growing your business
- Car repair
- Medical bills
However, there are a few P2P loans that come with restrictions. For example, some lenders may not let you use it for higher education. Also, most lenders will not permit you to use this loan amount towards gambling.