There has been a lot of talk about peer-to-peer lending in the world of personal finance recently. Because it allows people to get loans without going via a bank, this method of financing has gained popularity, especially among millennials.
Interest rates are just one of the many reasons why peer-to-peer lending is preferable to bank borrowing. Peer lenders are able to generate larger returns on their money and offer lower interest rates to borrowers than most banks because they don’t have to pay the hefty operating costs associated with running a traditional bank.
For borrowers who have had problems getting the best rates at banks, there are additional benefits.
How Does Peer-to-Peer Lending Work?
P2P financing, often known as peer-to-peer lending, is a newer kind of lending that eliminates traditional middlemen and brings together lenders and borrowers online. We’ll go into more detail about some of the most well-known websites that facilitate this kind of lending afterward.
As a borrower, you can expect a straightforward P2P lending experience. Getting a loan through a P2P lending platform is very much like getting a loan from a regular bank, except that the entire process takes place online.
The following items must be included with your application:
- Specific Identifying Data. Your name, date of birth, address, phone number, and Social Security number are all examples of such details. Your identity will never be revealed to your peer lender or group of peer lenders when you use a reputable lending platform to facilitate the transaction.
- Income. P2P lenders are much like any other lenders in that they need to get their money back, plus interest. To accomplish this, you must show that you will be able to pay back the loan. You’ll be asked for proof of income and where you get it.
- Allowance of Credit. Peer-to-peer lending platforms run potential borrowers through a credit check just as banks do. If your credit score is below average, your loan application can be rejected.
- Dollar Amount of the Loan. The requested loan amount must be communicated to the lending institution.
- Motivation for Taking Out a Loan. Finally, some online lending services demand that potential borrowers specify how they will put the money they receive. Although peer-to-peer (P2P) loans are unsecured loans, the reason for the loan is often displayed on the platform to the network of lenders, who may be more inclined to lend to a student who needs money for textbooks than to someone who wants to buy a motorcycle.
Loan Product Categories
A loan from a peer can be used for almost anything, although the most typical uses are:
- Individual Loans. No credit check is required for these loans. You may use the money for something like a vet bill or a vacation. In need of a personal loan for whatever reason? Ask around.
- Loans for Merging Debts. Credit cards and other unsecured loans tend to have higher interest rates than debt consolidation loans. This is a good choice to think about if you want to lower your interest costs and simplify your finances by combining all of your bills into one manageable monthly payment.
- Financing for Start-Ups and Established Small Businesses. The availability of low-interest financing for small businesses is quite limited. This is no longer the case, because of websites that match those in financial need with people who can help them. The majority of people who participate in peer lending are eager to lend money to a successful startup.
- The Cost of Higher Education and the Need for Student Loans. To cover the cost of tuition, living expenses, and books, many college students have turned to online platforms that facilitate loans between individuals.
How to Get a Loan from a Peer-to-Peer
P2P loan eligibility requirements are comparable to those of a conventional bank loan. Some of the most crucial requirements for qualification are:
In the same way that your FICO score affects your chances of getting approved for a loan and the interest rate you’ll pay if you do, it also has a significant impact on the terms of that loan. Because lenders on these sites are not protected by the FDIC, they stand to lose their money if they default on your loan payments.
- Low Credit Ratings. Borrowers with low credit scores might not be able to get a loan through a peer platform. Consider applying for a secured credit card and checking your credit report for errors if this is the case.
- Some peer-to-peer lenders insist on excellent credit from borrowers before they’ll approve a loan, but others will consider those with a less-than-perfect credit history. If you have a decent credit score yet are approved for a P2P loan, the interest rate you are charged will likely be quite high.
- Those with high credit ratings are more likely to be approved for peer-to-peer loans than those with poor credit ratings, regardless of the platform, they apply on. Borrowers with excellent credit ratings should expect interest rates that are far lower than those offered by most banks and credit unions.
Finally, if you have a great credit history, you will have the best opportunities to apply for a P2P loan with a low-interest rate. On these sites, lenders are most comfortable lending to borrowers who have a strong credit history.
Borrowers on most P2P lending platforms must fall into one of the following employment categories:
- Working a standard 40-hour workweek and receiving a regular income are both hallmarks of full-time employment.
- People who are self-employed can also access most of the credit options available through these channels. Be ready to show proof of income though, as doing so may lead to a loan denial even if you would have qualified under different circumstances.
- As long as they have the necessary credit history and their retirement income is sufficient to cover the cost of the loan after accounting for other household expenses, retirees who get a regular income are also eligible for peer-to-peer loans.
It doesn’t matter how high a borrower’s credit score is if they can’t prove they have a steady income.
The Ratio of Debt to Income
In the end, whether or not you are approved for a loan depends heavily on your debt-to-income ratio, which includes both traditional and peer-to-peer options. The debt-to-income ratio evaluates your financial situation by contrasting the sum of your monthly reoccurring debt with your monthly income.
It doesn’t matter what kind of loan you’re trying to get if you have a lot of debt compared to your income, you’ll probably have a hard time getting approved. With a good debt-to-income ratio of 36%, your monthly mortgage, rent, and other housing expenses should take up no more than 28% of your take-home pay.
If your debt-to-income ratio is higher than the aforementioned standards, you may want to work on paying down debt or finding a source of extra income before asking for a loan on a peer-to-peer lending site like Prosper or Lending Club.
The Advantages and Disadvantages of Peer-to-Peer Lending
There is a set of advantages and disadvantages to borrowing money from your peers. Borrowers should think about the following before applying for a loan through any online lending service:
Borrowing from peers, as opposed to more conventional lending sources like banks, can have several positive outcomes.
Here are a few of the most potential advantages:
- Rates of Interest Need to Be Reduced. Interest rates for P2P loans are typically cheaper than those offered by banks because these lenders don’t have the same costs to cover. Borrowers with high credit ratings will benefit the most from this.
- We Need Looser Standards. A peer-to-peer lender may be willing to lend to you even if you have been turned down for a loan by a traditional financial institution.
- Reduced Required Payments. Minimum payments on P2P loans are typically lower than on loans supplied by traditional lenders due to the lower interest rates and longer loan durations associated with P2P loans.
- There will be No Fees for Prepayment. Peer-to-peer loans, in the vast majority of circumstances, do not have a prepayment penalty. In other words, you can avoid paying any further interest by paying off your loan early if you have the financial means to do so.
As with any option, there are drawbacks to peer-to-peer loans despite their many benefits. Before applying for a P2P loan, here are several disadvantages to think about.
- Reduced Borrowing Costs. A friend or acquaintance is more likely to lend $100 than $1,000, and loans of $10,000 or $100,000 can be even more difficult to come by. The reason behind this is that most peer lenders lack the resources of a bank or credit union. The peer-to-peer lending model may not be the best option if you need a sizable loan.
- Origination Costs. There are instances where a loan funded through a peer-to-peer website will incur an origination fee. A lower interest rate than what is offered by regular banks may be offset by the loan’s origination expenses.
Best P2P Lending Sites
Multiple sites exist to facilitate the meeting of borrowers and peer lenders. There are many popular ones, but here are some of the most common:
- A Lending Club. Lending Club, founded in 2006, was one of the first websites to link borrowers with peer investors. It’s a major player in the peer-to-peer lending industry and a reliable resource for borrowers and lenders alike. Small business owners, those with a low debt-to-income ratio, and those who can get a co-borrower will find the finest terms and conditions with this company.
- Prosper. Prosper is another early player in the P2P lending industry, having launched in 2005. Prosper, like Lending Club, has expanded rapidly to become a major player among modern peer-to-peer (P2P) lending websites. Customers with strong credit ratings and low debt-to-income ratios will benefit the most from the site’s features.
- Upstart. Upstart, which has been around since 2012, is the go-to place for young companies to find the financial backing they need to get off the ground. The fees and rates on these business loans are more reasonable than what you’d get from a regular bank. Many small business owners value the opportunity to collaborate with their peers rather than faceless, faceless banks.
Getting a loan can be done in a number of different ways. A variety of new choices have emerged, however, making it possible for regular people to readily fund loans to their peers while also earning a return on their investment thanks to developments in technology.
P2P loans can vary greatly, just like conventional loans from banks. You should shop around for the best interest rate and terms before committing to any loan. Be wary of origination fees, and weigh their impact on the whole cost, against the potential savings from opting for a higher-interest choice.