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What is Peer-to Peer Lending?

Understanding P2P Lending

History of Peer-to-Peer (P2P) Lending

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Peer-to-Peer Lending Q&As

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What is Peer-toPeer (P2P) lending? What is its definition and how it works

By Julia Kagan

Updated December 20 20, 2022

Review by Thomas J. Catalano

Facts verified by Amanda Bellucco-Chatham

What is Peer-toPeer (P2P) lending?

Peer to peer (P2P) lending allows individuals to obtain loans directly from other individuals, cutting out banks as a middleman. Websites that facilitate P2P lending have dramatically increased their adoption as a different way of financing.

P2P lending is also referred to as «social lending» or «crowd lending.» It has been in existence since, but the crowd of competitors already includes Prosper, Lending Club, Upstart, and StreetShares.

Key Takeaways

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

P2P lending websites allow borrowers to connect directly with investors. The website sets rates and conditions and facilitates the transactions.

P2P lenders are individuals who want to get a better return on their cash savings that they would receive from a savings account at a bank or certificate of deposit.

P2P lenders are seeking an alternative to traditional banks, or the possibility of a lower interest.

For P2P, the default percentages for loans are much higher than the default rates for traditional finance.

Understanding Peer-to-Peer Lending

P2P lending websites connect borrowers directly with lenders. Each website sets the rates and conditions and facilitates the transaction. The majority of websites offer a broad choice of interest rates that are based on the creditworthiness of the applicant.

An investor creates an account with the site and deposits a sum of funds to be distributed in loans. The loan applicant submits an financial profile which is assigned a risk classification which determines the rate of interest the applicant will pay. The loan applicant has the option of reviewing offers and choose to accept one. (Some applicants cut their requests into smaller chunks and take multiple offers.) The money transfer and the monthly payments are processed through the platform. The process can be entirely automated, while lenders and customers can decide to haggle.

Certain sites are specialized in certain types of borrowers. StreetShares, for example, is specifically designed for small businesses.1 And Lending Club has a «Patient Solutions» category that links physicians who provide financing options with potential patients.2

The history of Peer-to-Peer (P2P) Lending

Early on the P2P lending system was seen as a way to provide credit to those who would be spurned by conventional institutions or a way for consolidating student loan debt at lower interest rates.

In recent years but, P2P lending sites have increased their reach. Most now target consumers who wish to settle credit card debt with a lower interest rate. Improvement loans and auto financing are also offered through P2P lending sites.

The rates offered to applicants with good credit tend to be lower than comparable banks, but the rates for those with less than stellar credit records may go much higher. LendingTree.com is an example. It provided personal loan rates ranging from 5.99 percent to 35.99% as of Dec. 15 2022.3 Peerform posted loan rates with a range from 5.99 percent from 29.99%.4 The average credit card interest rate was 19.59 percent as of December. 14th, 2022, according to CreditCards.com.5

To lenders, P2P loaning is an effective method to earn interest for their money at a cost higher than those offered by conventional savings accounts or certificates of deposit (CDs).

Some P2P sites permit lenders to begin with a with a balance as low as $25.

Special Takes into Account

Individuals who want to lend money via P2P lending sites should be aware that their borrowers will default on their loans like traditional banks are prone to do. The research of P2P lenders has shown that defaults are far more frequent than those faced by traditional financial institutions, often exceeding 10%.6

In contrast, the Index of the S&P/Experian Composite index for defaults for all types of lending for U.S. borrowers has fallen from about 1.55% to 0.59 percent in the ten years before November of 2022.7

Anyone looking at a P2P lending website must also look into the fees for transactions. Each site earns money in a different way, but fees and commissions may be due either to the lending institution, the borrower or both. Similar to banks, sites may charge loan origination fees, late fees and bounced-payment fees.

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

Peer-to-peer lending can be more risky than a savings account or certificates of deposit however the interest rates are usually significantly higher. This is due to the fact that those investing in peer-to-peer lending website assume the majority of the risk. This is typically taken on by banks and any other institutions of finance.

How big is the market for peer-to-peer (P2P) credit?

The market for peer-to peer lending was valued at $83.79 billion by 2021 according to figures from Precedence Research. This figure is projected to rise to $705.81 billion in 2030.8

How can you invest in lending through peer-to-peer?

The most straightforward way to invest in peer-to-peer lending is to create an account on a P2P lending site and then begin lending money to customers. These websites typically let the lender choose the profile of their borrowers, so they can choose between high risk/high returns and less risky returns. Additionally, many P2P lending websites are public companies, so one can also invest in them by buying their shares.

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