Peer-to-peer (P2P) lenders provide an online platform for connecting borrowers to lenders, without use of financial institutions as an intermediary. This significantly reduces the transaction costs of borrowing money, and allows for lower interest rates for borrowers.
There are two large P2P businesses in the U.S. – Lending Club and Prosper. They differ in a few ways, but operate in a similar fashion. Both allow personal loans between $2,000 and $35,000, typically with three- to five-year terms and fixed monthly payments.
You fill out a relatively simple application and the companies will assess your risk, much in the same way a bank does. However, instead of being reviewed by bank officers, your loan request (complete with interest rate and terms) will be posted for investors to evaluate. Assuming investors find your loan suitable, you will receive your funds in your designated account (generally within five business days).
Credit scores will be checked, as well as your bill payment history and typical risk factors. Both companies claim there is no effect on credit scores, although any defaulted loan is likely to be reported to the credit reporting agencies. A typical threshold credit score is around 640-660, but scores near 600 can be approved.
Both companies set interest rates starting around 5-6% for the best borrowers and near the 25-35% range for the highest-risk customers. The interest rate is adjusted by length of loan and amount of money but still depends primarily on risk.
The typical fee is 5% of the amount of the loan, and it can be as low as 1% for the lowest risk borrowers.
Is P2P lending right for you as a borrower? It may be in certain cases. Here are a few examples:
- Loan Consolidation – If you are trying to consolidate high-interest rate credit card bills, you can probably acquire a much lower rate – but you will have to convince investors that you will not use the opportunity to rack up even more debt with your freed-up credit. If you are in this cycle, no loan on Earth can help you.
- Temporary Unplanned Expense – Something like a wedding or unexpected medical bill that leaves you temporarily short of cash, but with sufficient future income to cover the bill, is well suited for P2P. One of the great advantages of P2P is that there are no prepayment penalties – so if you need cash short-term but are good for paying it back quickly, you can minimize the interest you will pay.
- Home improvement or Renovation – To finance a simpler renovation that does not merit the size (or the hassles) of a home equity loan, a P2P loan fills the niche nicely.
Keep in mind that whether it is a bank with a conventional loan or individual investors with P2P, you are still trying to convince people that you warrant minimal risk of repaying your loan. If you have horrible credit, you are still going to have trouble finding loan backers. In that case, the advantage of P2P is that you may be able to get a loan, even at a bad interest rate, when a bank will not lend you money at all. P2P certainly beats a payday loan establishment.
Overall, for borrowers, a P2P loan is a reasonable choice for midrange-sized loans, where you can improve upon the red tape a bank may apply to you, or an interest rate that a bank will charge you. It may also be your best option if your credit score is not quite good enough to qualify for a bank loan or a decent interest rate.
Also see Understanding What A Payday Loan Really Is.