P2P Lending Investing: How it Works
This article will discuss peer to peer lending investing to show you how it works as a lending alternative for borrowers. Also, you will learn what Peer to peer lending is, the pros and cons and who the lenders are and how to apply for a loan.
These days people now rely on Peer-to-peer lending instead of going to the traditional banks for loans. Most peer to peer loans are personal loans granted by individual lenders who want a higher return on their money. And borrowers could ask for loans of different types that range from debt consolidation to home improvement, or loans for small businesses.
Also, how it works is that a lending platform matches borrowers face to face with willing investors who are ready to lend them money using that platform.
Also, investors choose the loans and borrowers they want to fund based on their risk appetite. The matching part may be likened to traditional banks who select the loans they will fund based on a person’s credit record and capacity to pay back and collateral for the loan. Now that you have a fair idea of what peer to peer lending is, let me show you how peer to peer lending investing works.
Peer To Peer Lending Investing: How it Works
What is Peer-to-Peer (P2P) Lending?
Peer-to-peer lending is different from a bank or credit union. Also, when you get a loan from a bank, the bank funds the loan with its own assets, created from depositors. But this is not the case with peer-to-peer lending or social lending. In Peer-to-peer lending, the lending platform links borrowers with investors using its platform.
Besides, peer to peer lending investing, demands some guidelines. Also, the investor selects the type of personal or small business loans they are willing to fund. And the investor is also the one that will define his or her personal risk acceptance criteria when granting a loan.
Moreover, companies that grant peer-to-peer loans are commonly known as peer-to-peer lenders or marketplace lenders. And some select the type of people that will collect the loans. While some companies like LendingClub and Prosper put minimal limitations on the kind of borrowers they accept.
Other marketplace lenders, grant loans to only accredited investors (having incomes of $200,000 or $300,000 for joint accounts) or qualified purchasers (who must own at least $5 million in investments.) Also, some marketplace lenders lend only to institutional investors, like hedge funds, commercial banks, pension or endowment funds, and life insurance companies.
Furthermore, marketplace lenders generate revenue from borrowers by charging fees and collecting a percentage of the interest earned on the loan. Also, lenders charge borrowers origination fees, of about 1% to 6% of the loan amount, and late payment fees.
While the investor who lends money out collects a percentage of the interest accrued on the loan. For example, LendingClub takes a 1% fee of each amount the borrower repays. So, if a borrower repays $200 on a loan, LendingClub would take $2 before sending the balance to the investor.
Pros and Cons of P2P Lending
In the peer to peer lending investing method, it is not all borrowers that can borrow loans due to the advantages and disadvantages. See the pros and cons of borrowers.
Pros For Borrowers:
- it is a quick online experience
- They charge lower interest rates
- There is a fixed monthly payment
- You can check your interest rate without it affecting your credit score
- The credit requirements are not strict like traditional lending institutions
- Most of these loans are unsecured
- You have flexible use of funds
- And can get automatic repayment
- Also, there are no prepayment penalties
Cons for Borrowers
- The interest rates are up to 36% if you have a below-average credit score
- You may not qualify for a loan if you have a credit score below 630
- And you cannot borrow more than $35k to $40k
- Some websites have high fees, including origination fees up to 6%
- Also, if you miss repayments it will hurt your credit score
Pros for investors
As you consider peer to peer lending investing method, you would like to find out the pros and cons for investors. Here they are.
- You have a higher yield that is more than savings or CD account
- You have access to alternative investments instead of stocks and bonds
- Most platforms let you automatically vary your loan portfolio
- You are doing social good by lending directly to peers in the community
Cons for Investors
- There is a high risk of losing your money if borrowers default
- Lending is not covered by FDIC like insured savings or CD account
- There is less liquidity than stocks or bonds because of long-time horizons of three to five years
- This industry is new and could be unstable
- And some websites are only open to accredited investors
Peer to Peer Lenders
Peer to peer lending investing platforms are many. So, here is a list of some of the marketplace lenders in the U.S. that investors can go to. The primary lenders available to all investors are LendingClub and Prosper. The rest are Upstart, Kiva, Peerform, Funding circle, StreetShares, Sofi, Avant, Applepie Capital and others.
How to Apply for a P2P Loan
Many marketplace lenders usually check borrowers’ credit scores online. Also, you can apply in a few minutes. Note that each lender will have different requirements. But for personal loans, requirements include your credit score, debt-to-income ratio, salary, employment status, and credit history.
While for business loans, what is needed is the number of years in business, personal and business credit score, your debt service coverage ratio, revenue, and profits.
Besides, most lenders grant loans to borrowers who are 18 years of age and above and live in the same state they are located in. Finally, you must provide a verifiable bank account and a Social Security Number.
General requirements for P2P Loan
The general requirements of peer to peer lending investing are many. And, some of them are giving the lender your personal information; such as your name, address, birth date, phone number, and email address.
- And the requirements for personal loans, include information on your housing or mortgage payments, other outstanding debts, employment status and salary, educational history and details of the type of loan you want to borrow.
- Also, the borrower must verify some of this information by a photocopy of his/her I.D., pay stubs or W-2 forms.
- While for business loans, a borrower must provide information about the businesses financials
- And then submit documentation like tax returns, balance sheets, and profit and loss statements.
After submitting an application, a lender may offer a variety of loans. So choose the offer that best meets your needs. But you will have to submit to a hard credit check, which can affect your credit score. In addition, most peer-to-peer lenders will decide on a loan on the same day or within a few days. And the funding is fast, and borrowers could get these funds within 2 to 14 days.