Peer-to-Peer Lending

When most people think about borrowing money, they think about going to a bank. But peer-to-peer lending cuts out traditional financial institutions. using the Internet to put borrowers in direct contact with people willing to lend them money. Often referred to as P2P lending or social lending, this type of loan has become a popular alternative to the conventional personal loan.

Qualified borrowers pay interest rates lower than they could get on many other loans, while investors enjoy returns they might not earn elsewhere. The process amounts to a virtual environment of opportunity, in which people can borrow and lend on a more personal basis.

Peer-to-peer lending has been around since 2005 and has grown in the wake of the economic downturn. It began with ethnic-based groups in which lenders were familiar with members of the borrowing pool, leading to a mutual level of trust across the board.

As this type of lending has evolved, the lending groups have become less restrictive, enabling more lenders and borrowers to participate. Borrowers receive the capital they need, while the lenders get a greater return on their money than they would if it sat stagnant in their personal accounts. In recent years, checks and balances have been put into place to make peer-to-peer lending a more accessible option to the public.

Types of Peer-to-Peer Loans

Individually, P2P loans are typically worth $25,000 or less. But collectively in the United States, they add up to billions of dollars in outstanding loans. There are three main types of P2P loans available:

Personal Loans

These loans can be used for many different purposes, including medical bills, automobile purchases and home improvements. They can also cover debt consolidation. They are often easier to get through social lending groups because they don’t carry the same restrictions as those from financial institutions.

Business Loans

These loans can cover start-up costs such as marketing, facility maintenance and repair, or new-product launch expenses. Social lending groups are an attractive source for business loans because borrowers can present their loan proposals to multiple lenders, increasing their chances for approval.

Student/Educational Loans

These are typically lump-sum loans, which gives the borrower discretion on how to divvy up the money for school-related expenses. Although it is best to exhaust federal student aid options before considering alternative loans, social lending groups can offer competitive rates for students.

How Social Lending Sites Work

Social lending websites have a strong presence on the Internet. Borrowers should check the sites’ consumer reviews and ratings, and always read the fine print. A reputable site usually will not charge a fee for joining or making a loan request. The typical process has several steps:

1. Borrower signs up for an account. This is usually free and requires personal and financial information so the website’s platforms can pull credit history. proof of income and other information related to the loan.
2. Borrower makes a loan request. This is where the borrower has much more freedom than with a traditional bank because there is opportunity to sell the deal to potential lenders. Borrowers get to tell their story — what they are asking for, why they need it, and any related information that might make them more appealing to lenders.
3. Lenders consider the request. This process can be compared to the bidding environment on eBay. Lenders see an investment opportunity in which their disposable income can earn them a certain return. Sometimes one lender will fund all of a loan, while other times several lenders will pool their money — particularly if the borrower is considered higher risk.
4. The deal is closed. Once the lender or lenders agree to loan the money, the deal is closed and the parties sign off on terms. The website will monitor the loan over its life, collect the monthly payments, and distribute that money to the lender or lenders.

Future of Social Lending

Consumers are always looking for quicker and more convenient ways of borrowing money, so peer-to-peer lending appeals to many borrowers who may not want to deal with the paperwork and processing time required when dealing with conventional financial institutions.

Economic uncertainty remains an issue for social lending, however. Concern about defaults and the trustworthiness of borrowers has made many investors cautious, even as more people turn to P2P sites for funding. The rate of loan approvals has dropped, even as the number of applications has increased.