What is peer-to-peer (P2P) lending?

In a nutshell

Peer-to-peer (P2P) lending is a financial system that connects individual borrowers directly with lenders without using traditional banking or financial institutions. 

• This model leverages online platforms to facilitate loans between individuals, offering a more personalized borrowing and lending experience.
• P2P lending offers distinct advantages: You may qualify for lower interest rates as a borrower or earn higher returns as an investor. 
• Still, it also carries risks, such as the potential for higher costs or default rates.

How does peer-to-peer (P2P) lending work?

Peer-to-peer (P2P) lending is financial technology innovation to facilitate borrowing and lending money between individuals that is an alternative to traditional banking systems. This innovative approach connects borrowers directly with investors through online platforms, streamlining the loan process and often providing more competitive rates for borrowers.

Here’s a look at the key features of P2P lending:

• Application process: Borrowers apply for loans online, providing financial information and the purpose of the loan. This process is typically quicker than traditional long-form bank loan applications.
• Interest rates: P2P loans often have competitive interest rates, determined based on the borrower's creditworthiness. A higher credit score usually results in lower interest rates. However, depending on your credit score, you may encounter higher interest rates versus a traditional lender.
• Loan amounts: The available loan amounts can vary greatly, typically ranging from a few thousand to tens of thousands of dollars, making it suitable for various financial needs.
• Repayment terms: P2P loans offer flexible repayment terms, often ranging from one to five years. This flexibility allows borrowers to choose a term that best fits their financial situation.
• Fees: Borrowers should be aware of potential fees, such as origination fees or prepayment penalties. Fees vary by platform and should be considered when calculating the total cost of the loan.
• Risk assessment: P2P lending platforms assess risk differently than traditional banks; they often use unique algorithms that consider factors beyond credit scores. For example, they may consider bank account activity as evidence of financial stability.
• Investor involvement: One or multiple investors may fund a single loan, spreading the risk among several parties. This can impact the funding speed and loan conditions.

To better understand P2P lending, here’s an example. Imagine Sarah needs a $10,000 loan for home improvements. She applies on a P2P lending platform, where her creditworthiness leads to an interest rate of 8%. Multiple investors review her profile and collectively decide to fund her loan.

Sarah receives her funds within a few days of funding and begins to repay the loan over a three-year term with monthly payments. Each payment she makes is distributed among her investors, who earn interest on their investments. This process benefits Sarah with a competitive rate and quick funding — and allows investors to earn returns, diversifying their investment portfolios.

Is peer-to-peer lending safe?

For borrowers, P2P lending is as safe as traditional borrowing. Personal information is typically removed from the loan listings shown to investors, offering borrowers privacy and security. The P2P lending platform, similar to a bank or other online lender, retains personal information to facilitate the loan and repayment process.

For investors, P2P lending offers unique risks. It’s important to review each loan carefully and find the right mix of risk and reward. As the investor takes on the risk that the loan won’t be repaid, it’s wise to diversify your portfolio among many P2P loans (rather than concentrate your funds in a small number of loans). Just like the stock market, you may have successes and failures. Diversification helps spread out your risk.

Peer-to-peer (P2P) lending pros and cons

P2P lending isn’t all good or all bad. Here’s a look at the pros and cons of P2P lending.

Who offers peer-to-peer (P2P) loans

Here are some options to consider for P2P loans and P2P lending alternatives.

Prosper is an online marketplace that traces its roots back to the beginning of the P2P industry. Individual or institutional lenders match with borrowers looking for funds for personal loans.

Lending Club is another long-time participant in the P2P lending industry. Lending Club no longer allows individuals to invest in loans, but the borrowing experience remains mostly the same.

Upstart is a popular P2P lending alternative offering personal loans and car loan refinancing. You may find the best rates and fees here, depending on your credit.

Frequently asked questions (FAQs)

Can I make money from peer-to-peer lending?

P2P lending offers investors an opportunity to put funds into a loan with the potential to earn a profit as the loan is repaid.

What is an example of peer-to-peer lending?

The Prosper marketplace is an example of a P2P lending platform. With Prosper, individual investors and borrowers are matched to facilitate P2P lending.

What happens if you don't pay back a peer-to-peer loan?

If you don’t repay a P2P loan, you’ll typically see a significant negative impact on your credit score. You’re also taking money from individual lenders, causing them to incur a financial loss.