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Peer to peer loans

Updated on July 6, 2015

Peer to peer lending

What is peer to peer lending? In its basics, peer to peer lending is the same as any loan, one party that needs money borrows from another party that has extra money, and pays interest. The difference between bank loans and p2p loans is that banks are not involved. Usually it is not just one person lending money to another person, but rather dozens/hundreds of people lending money to one person. The two big names in peer to peer lending is Lending Club and Prosper.

Borrowing

There are a couple of reasons why someone may want to take out a peer to peer loan. Banks may be unwilling to loan money to people with lower credit scores, or people who may have had delinquencies in their past. While not everyone will be approved for a peer to peer loan, their restrictions are more than likely less stringent than traditional financial institutions. Since p2p lending sites don't offer other services like savings or checking accounts, you will not be required to use any other service to get the loan.

The other major advantage to borrowing with a p2p loan is the interest rate. Just like online retailers, peer to peer lending sites don't have as much overhead as brick and mortar institutions. This helps them to require less revenue to be profitable, so often they are able to offer lower interest rates than the traditional banks. Also, since they are not banks, they have fewer regulations to deal with.

Investing

Loaning money to people you've never met may not seem like a good idea, so why would anyone want to invest in peer to peer lending? The biggest draw for most is the chance to get a higher return on your investment than say a savings account or mutual funds. Prosper's website shows expected returns for their loans between five and fifteen percent, with an average return of ten percent. Lending Club claims similar expected returns. Since you are able to sort through the loans and cherry pick the best ones, you should be able to increase your return (though you can automatically fund loans as well).

Diversification is another draw. You always hear people advising you to diversify your investments in order to reduce your risk. This would be another option in which you could invest (in addition to say stocks, bonds, and real estate).

Restrictions and Secondary Market

There are some states in the US that restrict their residents from making these types of loans. Luckily, they do not restrict you from buying or selling already issued loans, only from actually issuing the loan (you should verify this before purchasing anything).

This secondary market can also be used by people that can directly issue loans. One strategy is to issue loans, then list them for sale to people who cannot issue loans due to their resident state. Another is to list loans that are late on a payment. This allows the lender to try and sell their loan at a discount in hopes of avoiding a complete loss of the remaining balance of the loan, while allowing a buying to purchase a very risky loan at a very low price, increasing the profit potential.

Kiva.org

Kiva is a different type of peer to peer lending. The borrowers are usually entreprenaurs and business owners in developing countries instead of american's consolidating their credit card debt. Lenders still make loans in $25 increments, but not for profit but for charity.

Some Kiva loans do work a bit different than others. When you issue a loan through Kiva, your money may not go directly to the person in the profile. It does go to the Kiva approved microfinance institution that made the original loan to the person and story you see in the profile. Your repayments are still tied to the borrower in the profile though.

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    • webrunner2023 profile image

      webrunner2023 5 years ago

      Didn't know about these loans. Might know someone who can use this.