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What is Peer-to Peer Lending?

Understanding P2P Lending

Peer-to peer (P2P) Lending

Special Takes into Account

Peer-to-Peer Lending Q&As

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What is Peer-toPeer (P2P) Loans? Definition and How It Works

By Julia Kagan

Updated 20th December 20, 2022

Review by Thomas J. Catalano

Fact checked by Amanda Bellucco-Chatham

What is Peer-to-Peer (P2P) lending?

Peer to peer (P2P) lending permits individuals to receive loans directly from other people, cutting out the financial institution as a middleman. Websites that allow P2P lending have significantly grown in popularity as a different way of financing.

P2P lending is also known as “social lending” or “crowd lending.” It has only been around since 2005 however, the list of competitors already comprises Prosper, Lending Club, Upstart, and StreetShares.

Important Takeaways

Peer-to-peer (P2P) loan is one form of technology in finance that allows individuals to loan or borrow funds from each other without having to go through a bank.

P2P lending sites connect borrowers directly to investors. The site determines the rates and conditions and facilitates the transactions.

P2P lenders are investors who want to get more money from their cash savings that they would receive from a bank savings account or a certificate of deposit.

P2P lenders are seeking an alternative to traditional banks, or a lower interest rate.

In the case of P2P loans, default rate loans are higher than the default rates for traditional finance.

Understanding Peer-to-Peer Lending

P2P sites for lending connect consumers directly to lenders. Each site sets rates and the terms and allows the transaction. Many websites have a wide variety of interest rates dependent on the creditworthiness of the person applying.

First, an investor opens an account with the website and deposits a sum of money to be dispersed in loans. The loan applicant posts an financial profile which is assigned a risk classification which determines the rate of interest the loan applicant has to pay. The loan applicant can review the offers and choose to choose to accept one. (Some applicants split their requests into chunks and then accept several offers.) The money transfer and monthly payments are processed through the platform. The process is completely automated, and lenders as well as borrowers can choose to haggle.

Some sites specialize in particular types of borrowers. StreetShares, for example, is specifically designed for small businesses.1 Additionally, Lending Club has a “Patient Solutions” category that connects doctors who offer financing programs with prospective patients.2

History of Peer to Peer (P2P) Lending

In the beginning the P2P lending system was thought of as a way to provide credit to those who might be rejected by traditional institutions, or as a way for consolidating student loan debt with a more favorable interest rate.

In recent years, in recent years, P2P lending sites have extended their reach. The majority of them target customers who wish to settle credit card debt at a lower interest rate. Improvement loans as well as auto finance are also offered at P2P lending sites.

The rates for applicants who have good credit scores are typically less than similar bank rates, while the rates for those with less than stellar credit scores could be higher. LendingTree.com is an example. It offered personal loan rates of 5.99% to 35.99% as of Dec. 15, 2022.3 Peerform posted loan rates with a range from 5.99 percent up to 29.99%.4 The average interest rate for credit cards was 19.59 percent as of Dec. 14th, 2022 according to CreditCards.com.5

For lenders, P2P loans are a way to generate interest income from their funds at rates which is higher than those provided by traditional savings accounts or certificates of deposit (CDs).

Some P2P sites permit lenders to start with an account that has a balance of just $25.

Special Takes into Account

Anyone who wants to lend money using P2P lending sites must be aware of the possibility that their borrowers will default on their loans, just as traditional banks are prone to do. The research on P2P loan platforms have revealed that defaults are much more common than those facing conventional financial institutions often more than 10%.6

In contrast, the S&P/Experian composite index of default rates across all kinds of loans made to U.S. borrowers has fallen from 1.55% to 0.59 percent in the ten years prior to November of 2022.7

Any consumer or investor looking at a P2P lending website should also check the fees for transactions. Every website makes money in different ways However, commissions and fees can be due at the expense of the borrower, the lender borrower, or both. Like banks, the sites may charge loan origination fees, late fees, and bounced-payment fees.

Is peer-to-peer lending (P2P) safe?

Peer-to-peer lending is riskier than a savings account or certificates of deposit but the interest rates are often significantly higher. This is because those that invest on a peer to peer lending site assume most of the risk. This is usually the responsibility of banks or different financial institutions.

How big is Peer-to-Peer (P2P) lending?

The market for peer-to-peer lending was worth $83.79 billion as of 2021, according to data from Precedence Research. The market is expected to be $705.81 billion by 2030.8

How do you make an investment in peer-to peer lending?

The simplest method of investing in peer-to peer lending is to create an account with a P2P lending site and begin lending money to borrowers. The majority of these sites let the lender choose the profile of their borrowers, so they can choose between high risk/high return or lower returns. Alternatively, many P2P lending sites are public companies, so one can also buy their stock.