Peer-to-peer lending is a process in which those looking for a way to make a profitable investment offer loans typically to those who want to start or grow a business of some kind. This type of lending is done on website platforms where lenders are matched up with borrowers. Not to be confused with angel or peer-to-peer investing, each financial arrangement made is considered a loan and is almost always preceded with credit and other security verifications before it's a done deal.
Because there are no banks or other financial institutions involved with the peer-to-peer lending process, borrowers can usually get a slightly better deal when it comes to negotiating interest rates and sellers can take advantage of improved headline rates.
How Exactly Does it Work?
In peer-to-peer lending, people who are looking to invest any significant amount of money are the lenders. Their money is typically invested into the peer-to-peer platform they are using and from there, a loan can be made to someone who fits the risk factors, credit worthiness, and demographics that are preferable to the lender.
The peer-to-peer platform is supposed to function as a buffer for the lender in case things go wrong and the borrower doesn't or can't pay the entire loan back. In April of 2014 the Financial Conduct Authority began regulating these platforms to help ensure protection for all parties involved.
These regulations require peer-to-peer platforms for have a plan in place for loans that don't pan out as planned. And by April of 2017 these platforms must have capital that will help to back loans that fall through or other financial problems. Some platforms have plans set up with third party servicers that would ensure lenders are still paid back by borrowers over time.
What are the Pros and Cons of Peer-to-Peer Lending?
One of the major benefits of peer-to-peer lending is the flexibility it offers. The loan can be contracted between two people from across the World without ever having to sit down face to face. Most platforms are easy to use and manage which makes for quick investment and loan opportunities. Borrowers have access to a myriad of lender options which is a positive contrast to working with a single bank. For lenders, large returns (think 10-percent) are an attractive feature of peer-to-peer platforms for lenders.
Of course, there are some risks that should be considered before making use of peer-to-peer platforms. Probably the biggest risk lenders face is the chance that borrowers will default on their loans. Luckily there are some protections put into place, like credit checks, but this doesn't guarantee a payback. So for lenders it makes sense to diversify and invest in hundreds of different loans as opposed to focusing on, say, only ten. And with peer-to-peer platforms this is easily doable.
Another risk is poor underwriting. While it's highly unlikely, there is always a chance that a peer-to-peer platform starts to poorly underwrite their borrowers. This means that important things like income verification and credit are somewhat overlooked in favor of increasing borrowers on the platform. This is why it's important to work with a well known platform that implements solid structure and guidelines for both borrowers and lenders.
What are the Best Peer-to-Peer Platforms?
There are several excellent peer-to-peer platforms to work with, choosing one will really depend on your own personal preferences and needs. Here are a few that shouldn't be overlooked:
Landing Club is the largest peer-to-peer lending platforms in the United States. Each year for the last few years they have managed to grow by more than 100-percent, and they've helped secure more than 5 billion dollars in loans/investments for their clients.
Prosper was founded in 2006 and has since secured more than 1 billion dollars in loans for borrowers. They currently serve more than 2 million members and continue to grow on a monthly basis. It offers secure risk mitigation and plenty of diversification options.
This company was founded in the United Kingdom but has started offering services to clients in America. Funding Circle tends to focus on small business loans that were overlooked by the banks.
There are also several platforms, such as Zopa, that operated within the United Kingdom. Some platforms even focus on matching lenders in first world countries with borrowers from third world countries.
It's possible for both borrowers and lenders to tap into several different platforms at once, but because most big platforms cover all the bases in terms of services, protection, and convenience, finding a good fit and sticking with it is probably the best lending and borrowing strategy to take.
Overall peer-to-peer lending has more benefits than disadvantages for both parties involved. Like everything else, personal due diligence is the single best way to ensure investments and loans are managed properly.