As technology continues to evolve, and more people continue to embrace the evolution, operational convenience keeps improving. Peer-to-peer system of lending is as old as humanity. The practice involves just two parties. One who has an interest in making a return on investment and the other who needs finance. Here’s an overview of all there is to know about Peer to peer lending.
What is Peer-to-peer lending?
Peer to peer lending (P2P lending), also known as social lending. It refers to a loan transaction that does not involve a bank or financial institution involved. Instead, the lender is an investor looking to make a return on their investment (the loan). The borrower on the other hand is borrowing money from the investor directly.
These loans are facilitated by technology platforms that connect the lender with the borrower so that they can transact anonymously. This modern approach to lending and borrowing money comes with several advantages and a couple of disadvantages too.
How does Peer-to-Peer lending work?
Peer-to-peer lending is partially a straightforward process. All the transactions are carried out through a specialized online platform. The steps below describe the general P2P lending process:
- A potential borrower with interest in obtaining a loan completes an online application on the peer-to-peer lending platform.
- The platform assesses the application and determines the risk and creditworthiness of the applicant. After the assessment process, the applicant is assigned with an appropriate interest rate.
- After approval, the applicant receives available options from the investors based on his credit rating and assigned interest rate.
- The applicant can evaluate the suggested options and choose one of them.
- The applicant pays periodic (usually monthly) interest payments and repaying the principal amount at maturity.
The company that maintains the online platform charges a fee for both borrowers and investors for the provided services.
Advantages of peer-to-peer lending
It provides some significant advantages to both borrowers and lenders. Some of these advantages includes;
- Higher returns to the investors: P2P lending provides higher returns to the investors relative to other types of investments.
- More accessible source of funding: For some borrowers, peer-to-peer lending is a more accessible source of funding than conventional loans from financial institutions. This may be because of the low credit rating of the borrower or a typical purpose of the loan.
- Lower interest rates: P2P loans usually come with lower interest rates because of the greater competition between lenders and lower origination fees.
Disadvantages of Peer-to-Peer lending
It comes with a few disadvantages. Some of these advantages includes;
- Credit risk: Most Peer-to-peer loans come with high credit risks. Many borrowers who apply for P2P loans possess low credit ratings that do not allow them to get a conventional loan from a bank. Therefore, it is important that a lender should know the default probability of his/her counterparty.
- No insurance/government protection: In case of the borrower’s default, the government does not provide insurance or any form of protection to the lenders.
- Legislation: Some jurisdictions do not allow peer-to-peer lending or require the companies that provide such services. This sanction is imposed in order to comply with investment regulations. Therefore, it may not be available to some borrowers or lenders.
Conclusion
As more and more people begin to feel comfortable with technological advancement, Peer-to-peer lending continues to grow in popularity. It is also becoming a much more viable option for people who need money and for people who want to invest their money.