What Is Peer-to-Peer Lending?

What is Peer to Peer lending - picture of cash changing hands

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If you think peer-to-peer lending is only for the rich, you may want to reconsider.

Earning money with peer-to-peer lending is possible for regular people like you and me. It isn’t nearly as overwhelming as the pros make it seem, and it’s pretty easy to get started.

Whatever your financial goals – saving for retirement, looking for new income streams, or anything else – peer-to-peer (P2P) lending can help you get there.

If you’ve been thinking about investing with P2P lending, that’s great news! To help you get started on your money-making journey, here’s what you need to know.

What is Peer-to-Peer Lending?

P2P lending provides an option for one person to borrow money from someone else. Instead of going to the bank or credit union to get a loan, borrowers connect with investors through a peer-to-peer lending platform.

By cutting out the financial institution as a middleman, it’s a win-win for the borrower and the lender.

Borrowers have easier access to money and could qualify even if a traditional bank denied them. On the flip side, lenders often have the opportunity to earn more on the funds they loan to others than they would on typical fixed-rate investments.

How Does Peer-to-Peer Lending Work?

Using a lending platform such as Lending Club or Prosper, borrowers connect directly with lenders. The website takes care of setting the terms of the loan and handling the details of the transaction, making it super easy for you to invest.

As an individual lender, the funds you deposit go into a separate account. Depending on how much you deposit and the needs of the borrower, your money might be enough on its own to fully fund a loan. But most often, it’s pooled together with money from other investors to provide loans to applicants.

You’re in control of which borrowers you lend your money to, and you can review several offers before accepting one. Before you release your funds, you’re able to evaluate the applicant’s profile to assess the risk.

Once you decide to invest in a loan, the borrower will agree to pay back the original amount plus interest.

Investing Your Money

Keep in mind that you’re not required to put all your funds in one place. Some investors spread their money across several smaller loans as a way to balance their investment risk.

Investing as little as $25 of your funds per loan is possible. If you start with $1,000 in your account, you could spread it across 40 different investments. This low threshold lets you invest in just one or several loans based on your risk tolerance.

Like most banks, you can make money off the interest that’s paid by the borrower. The specific rate depends on the credit rating of the applicant. Generally, higher credit scores qualify for lower interest rates.

This means you stand to make the most from borrowers with poor credit since they’ll pay the most in interest. But they come with a higher level of risk. There’s a chance the loan could become delinquent. If that happens, the lending platform will work with the borrowers to collect any past-due payments.

Investing with P2P lending can earn you a great return on your cash. You’ll make money on the interest rate charged to the borrower and have access to the platform’s collections team if there’s a problem.

Types of Loans Available Through P2P Lending

When you’re looking to invest, it’s a good idea to know where it’s going. Borrowers can apply for several different types of loans that are crowdfunded with peer-to-peer lending.

Before giving the green light to disperse your money, you can review what the purpose of the loan is. These are a few types of loans you might see with P2P lending.

  • Personal LoansPersonal loans have a variety of uses. Sometimes the extra money helps cover gaps in cash flow between paychecks. Weddings and vacations are also common reasons for a personal loan.
  • Auto Loans – These are for buying a new (or used) car or to refinance a current auto loan. Interest rates could be lower than what you’d see at a traditional bank, and that can offer lower monthly payments. Most lending sites have an instant prequalification process to see what you might qualify for. You can check your rate without it affecting your credit score.
  • Debt Consolidation – You can’t borrow your way out of debt, so be very careful with debt consolidation loans. It won’t work unless it can actually save you money. If you qualify for a lower interest rate, the numbers might work out in your favor.
  • Medical Loans – Some procedures require payment upfront. Without the cash on hand, taking out a medical loan might be a good move to get the care you need. From dental work, allergy testing, or other medical procedures, P2P lending could provide money for healthcare needs.
  • Mortgages and Refinancing – If you thought P2P lending only dealt in small amounts, this will change your mind. Yes, you can borrow crowdfunded money in a large enough amount to cover a mortgage. Refinancing your current mortgage for a better rate is also an option.
  • Small Business Loans – Instead of using your personal savings to fund your startup, this might be a better option. A small business loan with a P2P platform can help you purchase equipment, cover payroll, or expand your location.

Who Should Invest in Peer-to-Peer Lending

Fixed-rate investments are safe, but you don’t get much of a return. Even the best high-yield savings accounts top out at 2.45%. They are FDIC insured, however, so there’s almost no risk of losing your money.

But if you’re tired of earning peanuts on your investments and you don’t mind taking a little bit of risk, P2P investing might be a smart move. It definitely has a potential for higher returns with reports of 8% or more.

Some states have strict rules about getting started with P2P lending. Most have minimum gross income and net worth amounts you must meet to qualify. When you sign up for an account, it will ask you a series of questions to make sure you meet the requirements.

Before you invest in anything, make sure you understand what you’re getting into. There’s no underwriting process like you’d see with a traditional bank. Plus, it isn’t FDIC insured.

Pros and Cons of Peer-to-Peer Lending

If you’re looking for investment opportunities or need to borrow money, P2P lending an excellent option. There are plenty of advantages if it’s something you’re interested in. But don’t overlook the downsides.

For Investors

Easy way to diversify portfolio investments beyond stocks and bondsCan’t buy or sell as quickly as stocks or bonds
Contributing to the good of society by lending directly to peersRisk of losing money if borrower doesn’t pay it back
Higher yield possible when compared to savings accounts or CDsNot FDIC insured
Tap into collections help if the borrower defaults on paymentSome states have strict requirements to invest

for Borrowers

Online applicationPoor credit rating can result in high interest rates
Often instant approvalWatch for origination fees that could go up to 6%
Can see rates without impacting your credit scoreMight not qualify with a credit score less than 630
May qualify for loans even if you don't at a bank
Fixed monthly payment
Lower interest option

Is Peer-to-Peer Lending Right for You?

When it comes to investing, earning more is the goal. P2P lending gives you a chance at higher returns than what you’d get with a fixed-rate investment product like a savings account or CD.

As a relatively new industry, P2P lending offers huge potential. There is some risk since it isn’t FDIC insured, but it also might help you reach your financial goals while giving you the chance to help others with theirs.

If you’re looking to diversify your investments beyond stocks or bonds, P2P lending is a pretty sweet way to get your feet wet and earn some money while you’re at it.

Have you tried P2P lending? Give us your thoughts in the comments below!What is peer to peer lending - picture of cash changing hands pin

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