Peer to Peer Lending: The Advantages and Disadvantages
Updated: Sep 19, 2022
Peer to peer lending (also known as P2P lending) has exploded in popularity over the last few years, with billions of pounds and dollars flowing through these online platforms each year.
This system allows individual investors to lend money directly to borrowers, who can then repay loans with interest rates as high as 10%-20%.
However, this type of lending has both advantages and disadvantages. In order to make an informed decision about your future loans and investments, it’s important to be aware of all the facts about peer to peer lending so you can decide whether or not it’s right for you.
Advantages of peer to peer lending
Peer-to-peer lending offers several advantages for both lenders and borrowers. For example, peer-to-peer lending can help individuals build credit history by making timely payments on time, thus leading to lower interest rates on future loans or credit cards.
Peer-to-peer lending also can provide an opportunity for investors who aren’t satisfied with returns offered by traditional savings vehicles.
If a borrower fails to repay their loan as promised, most peer-to-peer platforms offer a return of capital (ROC) guarantee that ensures investors will get some of their money back if they are held liable.
And finally, peer-to-peer lenders also may offer fixed interest rates without any of the hidden fees often associated with many banks or payday loan companies.
Is it easy to borrow?
Yes, if you have great credit. Peer-to peer lending sites use credit scores when determining an individual's ability to pay back a loan. If your score is above 680, you'll be approved for a loan in most cases.
If your score is below 680, peer-to-peer lenders will likely consider other factors such as income, savings and employment history before approving you for a loan. This process takes time because lenders want to ensure that their money isn't wasted on someone who won't pay it back.
However, if you fall in this category there are still other opportunities available for borrowing money from friends or family members without interest rates attached. Peer-to-peer lending is not your only option; shop around!
How much can you borrow?
You’ll find that most peer-to-peer lending companies cap how much you can borrow at £25,000. This limit applies in general to all applicants, although each company has its own criteria.
Peer-to-peer lending isn’t a good option if you need a large amount of money—or if you need it in a hurry. One positive of peer-to-peer lending is that most companies let you invest as little as £25 into several loans.
You should be aware, however, that your returns on investment will be smaller than they would be with larger investments because more people participate in small pools of money.
What are the interest rates?
Peer-to-peer lending offers one huge advantage over traditional lending – your rate can be negotiated. Some sites, like Prosper and Lending Club offer a few different rates based on your credit score.
If you have an excellent credit rating, you may be able to secure a rate of as low as 6%.
However, if your credit is less than stellar (particularly if you have any kind of delinquency or loan default in your past), it’s possible that a site will charge you upwards of 25%!
Before applying for peer-to-peer loans, make sure you understand what rates lenders are offering – both good and bad.
Are there extra charges?
Peer-to-peer lending is one of the only ways individuals can invest in loans directly, giving them more control over their investments than they would have with traditional financial products.
Most peer-to-peer platforms allow investors to choose which loans they want to purchase, usually at a fixed rate, which avoids extra charges that may come with traditional financial products.
For example, your bank may charge you fees every time you withdraw or deposit money from your account.
Additionally, most peer-to-peer lenders don't charge origination fees—meaning you won't be charged for issuing or funding a loan.
Is a credit rating required?
Peer-to-peer (P2P) lending allows people who aren’t able to obtain financing from traditional lenders to get a loan for a reasonable interest rate.
To protect investors, most sites require that you have a credit rating of at least 600 or so before you can apply for a loan.
Your credit score might make it difficult for you to obtain some of your loans through peer-to-peer lending, but if your circumstances fall within certain parameters, getting money through P2P is worth investigating.
Who qualifies as a borrower?
One of the most important aspects in peer-to-peer lending is qualifying as a borrower. Those with bad credit often do not qualify for loans through conventional channels, which makes peer-to-peer lending an excellent alternative.
Additionally, those with high debt loads may have difficulty finding lenders willing to extend them credit.
Peer-to-peer lending tends to give people another chance who may have been excluded by traditional banks due to poor credit or large amounts of debt.
However, borrowers should be aware that peer-to-peer loans tend to carry higher interest rates than traditional bank loans due to risk factors associated with these individuals.
There are some risks involved...
Peer-to-peer lending takes away your bank or credit union's role as middleman. This means you can borrow and lend directly from peers, rather than having a financial institution act as a go-between.
However, peer-to-peer lending does come with some risks for investors that are not present in traditional lending through banks.
For one thing, there is no set rate of return on your investment—if loans default at higher rates than anticipated, you may lose money on your investments.
Peer to Peer Lending: The Advantages and Disadvantages - The bottom Line
Peer-to-peer lending can have a few benefits, but it’s important to be aware of some of its disadvantages as well.
Peer-to-peer lending isn’t for everyone; if you want high returns and low risk, P2P probably isn’t right for you.
However, if you want some attractive rates and enjoy helping people out with their finances while taking on a little risk yourself, peer-to-peer lending could be an interesting option.
Just make sure that you do your research before diving in!