The Ins and Outs of Peer to Peer Lending

January 20, 2015 By: Chris Fuller

For nearly a decade, peer to peer lending has been all the rage. Not only does this have benefits for those who are looking to borrow money, but the same holds true for individuals who are willing to lend their cash.

Before we go any further, let’s take a closer look at the definition of peer to peer lending, as provided by Investopedia:

“A method of debt financing that enables individuals to borrow and lend money – without the use of an official financial institution as an intermediary. Peer-to-peer lending removes the middleman from the process, but it also involves more time, effort and risk than the general brick-and-mortar lending scenarios.”

Who Uses this System?

Traditionally, a person in need of a loan would visit a local bank to discuss their options. With peer to peer lending, this is no longer required. Instead, a borrower is able to request the money they require from other individuals.

Many people use this type of borrowing system for a variety of reasons, including but not limited to taking on a home improvement project, paying an unexpected medical bill, and buying a car.

The Pros and Cons

Before you get started with peer to peer lending, either as a borrower or lender, it is essential to understand the pros and cons. This is a big financial decision, so you need to know what you are doing every step of the way.

Here are three borrower benefits:

• Ability to secure a loan, despite the fact that a bank has denied you due to poor credit or other circumstances.
• Faster process, allowing you to get your hands on the money you need in a shorter period of time.
• Lower interest rates than a local bank. This is not always the case, but it could work out this way for a person who has an above average credit score and solid credit history.

On the downside, consider the following:

• Some borrowers do not qualify because their credit score is too low.
• There is a lot of work that goes into the process, especially when it comes time to make a final decision on who to borrow money from.

While some people are only interested in borrowing money through a peer to peer lending service, others become part of the other side. These are the lenders.

The primary benefit to a lender is simple: the person has the ability to earn more money in interest than they would through a traditional investment, such as a CD or savings account.

Another benefit has nothing to do with money and everything to do with good will. Some people are down on their luck and unable to get a bank loan. You can help this person out by lending them the money they need. Of course, you must always have your best financial interests in mind.

There is a downside of being a peer to peer lender. The biggest risk is the chance of default. Just because you lend somebody money doesn’t mean they have to pay it back. Additionally, your funds are not typically insured.

The Top Peer to Peer Lending Services

If peer to peer lending sounds like something for you, either as a borrower or lender, it is time to learn more about the major players that make up the industry.

While there are always new services popping up, it is best to stick with those that have been proven reputable over the years. Here are the top five peer to peer lending sites:

• Lending Club. Founded in 2007, this service has been around for many years and has facilitated billions of dollars in loans.
• Since 2006, Prosper has been a dominant player in this space, thanks to its user base of approximately two million members.
• Funding Circle. This site may not have the same name recognition as the two above, but it is a top provider in the United Kingdom and is now growing into the United States.
• This company is relatively new to the game, being founded in 2012, but it is already making noise.
• Founded in 2005, Kiva takes a different approach to peer to peer lending. It is a non-profit organization with the goal of helping individuals in developing nations, via a peer to peer lending platform.

Conclusion

The peer to peer lending industry is still in its infancy. That being said, borrowers and lenders continue to rely on the services above, among others, to get involved. Understanding the pros and cons, as well as other related details, is the best way to understand if this is the right financial decision for you.

Chris Fuller

Chris Fuller went to the University of South Florida and has worked in the financial sector for over 20 years. He has extensive experience in all aspects of personal and small business lending, from personal loans, equipment finance to cash flow based solutions for small mom and pop businesses, and large corporations.