Peer To Peer Lending: 4 Reasons To Turn Away From Big Banks

P2P lending is Growing

The recession of ’08 and the economic slowdown that followed stretched everyone’s finances thin. As the economic conditions continue to dwindle, banks are clamping down on lending and are choosing to extend loan services to their bankable, collateral-rich customers. Say you’re a common Joe and wish to finance your daughter’s wedding or start a new business, but you know you don’t own enough assets or cash to fulfill that dream. How do you take out a loan?

As banks made borrowing tougher, Peer-to-Peer lending ushered in to meet the rising demands for credit. Peer-to-peer (P2P) lending is the practice of lending money via online platforms that match individuals who seek to borrow to the ones seeking to invest. Companies that facilitate P2P lending act as intermediaries between the borrower and lender, offering lower interest rates for the borrower and higher returns for the investors as compared to traditional financial institutions.

Even though P2P has been active in the USA for more than a decade, it’s escalating popularity in recent times is a testament to the fact that the way we borrow and invest is witnessing a massive shift. Traditional methods are slowly being replaced with their digitized counterparts that help ease the process – so instead of haggling with a broker and a bank representative over massive piles of paperwork and high interest rates, you only deal with a mobile app while sitting in the comfort of your home/office. Moreover, P2P lending is an attractive alternative for individuals who seek to consolidate their credit card debt at lower rates than what banks would offer.

Reasons to try peer to peer lending:

P2P lending fills some major gaps left by traditional lending sources and can significantly reduce dependency on big banks. Even though there is a small sum charged by the online portal, the cost is quite nominal and often worth the service provided. So if you’re willing to wander across the boundary of conventional financial institutions, here’s four reasons why you should definitely consider P2P lending –

1. Higher Returns – As compared to formal lending institutions like banks, P2P lending offers higher returns and shorter terms with a fraction of the hassle that banks are bound to give you. Typically, P2P lending offers competitive returns, anywhere between 7%-39% depending on the deals. Online portals that facilitate P2P lending vet the borrowers. By checking the objective of the loan, repayment plan, business plan, as well as credit profile, repayment history, delinquencies, type of employment, income, and even SAT scores to gauge a borrower’s creditworthiness, the interest is fixed.

2.  No need to fully fund the loan – For a lender, one of the lesser understood benefits of P2P lending is that you don’t need to fund the entire loan amount. Dip into your savings that are lying idle and shell out only as much as you’re comfortable with. Or perhaps you could choose to fund parts of more than one loan, which may save you from the mess of defaulting of loans. So if your savings are sitting in the bank collecting dust, you could consider loaning it in either whole or in parts via P2P lending.

3. Create a portfolio based on your criteria –  In P2P lending, your capital as an investor is spread into ‘notes” of smaller denominations. As you don’t need to fund one single loan to its completion, you can easily build a diversified portfolio of investments in the due course of time.  

4.  Connect the retirement account – Even though traditional retirement saving instruments offer guaranteed principal, they do very little for value creation. With its high rate of return, investing in P2P loans is a smart way to diversify your portfolio, compound your earnings and boost your retirement account. 

The risks in P2P Lending

However, as compelling as it may sound, P2P lending is not without a few perils of its own. Most P2P loans are oftentimes secured to a valuable asset or collateral that backs the borrowing, but it is generally not a requirement – making them unsecured as compared to loans from traditional banking institutions. As a lender, the amount you shell out to the borrower is essentially a loan and is tied up with the term, hence you cannot really ask the borrower to repay the loan in case you face an emergency. This creates a liquidity risk for the lender. The Government does not provide any kind of insurance if the borrower defaults, and the borrower may also restructure their repayment plan. There is also no way to secure yourself in a situation where the platform closes shop. With fewer restrictions on borrower eligibility and no such insurance against defaults, this really begs the question about the protection of lenders against such situations.

Main P2P lending players

Let’s dive in to briefly study the main players of P2P lending in the USA –

1. Lending Club

Lending Club started in 2007 and offers 4 distinct types of solutions for your borrowing needs – Personal loans up to $40,000 for clearing off your personal debts, business loans up to $300,000 for businesses operating for at least a year and with at least $50,000 in annual sales, as well as about $50,000 as loan to finance your medical bills. Lending Club is especially known as the go-to option if you’re looking for auto refinancing.

2. Upstart 

Upstart was founded by 3 ex-Google employees and is one of the most innovative and technology-savvy P2P lending platforms. The platform was launched along with spontaneous software for banks and financial institutions. One of their USPs is how they determine risk – with a system that uses Artificial Intelligence that gauges the borrower’s creditworthiness by looking into their FICO score, education, credit history, area of study as well as job history. According to market experts, the use of such technology has significantly lowered the default rates as compared to some of the other players. Upstart offers loans anywhere between $1,00-$50,000 at rates as low as 8.85%.

3. Peerform 

The founders of Peerform sought to provide borrowers with a clear, fast and fair loan process. Founded by Wall Street executives in 2010, Peerform is therefore rightly known for fair credit in the market. Investors can choose between Whole or fractional loans, with options to customize their portfolio. With interest fixed at 5.99%, the platform offers loans between $4,000- $25,000 with an additional one-time fee that amounts to anywhere between 1-5% of the loan.

4. Prosper 

Prosper platform opened operations in 2005 in the USA and is probably the oldest platform dealing with P2P lending in the USA. According to experts, Prosper is the place to go if you’re looking for a loan to carry out debt consolidation. Prosper offers personal loans up to $40,000 with a fixed rate and fixed term (generally 3-5 years). For the lender, Prosper offers seven distinct categories of risk to select from that come with their own calculated returns.