How Peer-to-Peer Lending Works

Peer-to-peer lending usually abbreviated as P2PL allows individuals or firms to borrow money bypassing the traditional role of borrowing money from the bank. While this kind of lending is similar to peer-to-peer investments, there is a great difference between the two terms in that peer-to-peer lending takes place online on lending websites through various platforms. Loans advanced through P2PL are usually unsecured and are mostly given to individuals rather than companies. Examples of peer-to-peer lending include student loans, commercial or real estate loans, leasing, and factoring. So one may wonder how this kind of lending works and whether or not it has any benefits to both the lender and the borrower.

How it works

The borrower first makes an application to the lender for a loan. The lender then makes an assessment of the credit risk of the borrower among other factors. The higher the risk of default by the borrower, the higher the interest rate, this allows the lenders to mitigate risk of loss. Remember unlike secured investments no security is required for these kinds of loans. The lender also has the privilege of choosing which borrower to lend to and alleviating the total risk by diversifying the investment to other borrowers. Lenders then bid for the loans by buying portions of the loans advanced by the borrowers. The portions can be as low as fifty dollars depending on the kind of portfolio the lender wants to create. The bidding process may slightly differ from one company to another but using the same principle.

Benefits to the borrowers and the lender

To the borrower

  • The borrower benefits as he obtains a loan at a lower rate than the rate advanced in banks.
  • The time taken to advance the loan to the borrower is shorter as the process is shorter.
  • There are fewer overhead costs associated with the loan.

To the lender

He gets higher returns on his money compared to if he had placed the funds in a savings account.

While the whole process of advancing loans is safe, P2P lending involves a certain amount of risk to any lender. However, as earlier mentioned, the best way to mitigate the risk involved is by conducting research on the credit rates assigned by the companies and purchasing several loans so as to diversify your funds. Lenders are advised to invest in reputable companies as it is similar to assuming the same amount of risk as a bank only on a smaller scale.

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Vincent Garibaldi

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