Peer-to-peer loans have grown in popularity since first being introduced to the United States in 2006. While not a traditional form of lending protected by government insurance, this alternative financial service is backed by the Securities and Exchange Commission (SEC), making the process more transparent and safer in light of the recent financial crisis.
Person-to-person lending is as a way for lenders and borrowers to connect directly. The contact and loan process takes place online, enabling both parties to be able to communicate without an intermediary, like a bank or other financial institution.
Peer-to-peer loan websites are community-based and overseen by a company that manages the website and lending platform. As peer-to-peer loans are unsecured loans – meaning that no collateral is needed – approval of the loan is based not only on your credit score but also by your personal story. On the peer-to-peer loans website, you can create a post, much like that on a forum, where you would state much you are looking to borrow, what interest rate you’re willing to pay, and what the loan is needed for.
Based on your story, as well as other qualifying information, individuals will contribute a portion towards that your loan. Individual lenders, or investors, take into account both the story of why the loan is needed as well as the risk associated with your assigned credit grade (your grade is based on your credit score).
Person-to-person lending is considered unsecured – all that’s needed on your part is your signature since no collateral is required. Typically, there are no pre-payment penalties and fixed interest rates.
There are, however, fees associated with these types of loans and these fees vary from person-to-person lending platform. Usually, the fees are based upon a credit grade that is assigned to you. For example, a peer-to-peer platform might assign a great credit grade as an “AA”; in this example, your fees could be one percent of the loan amount. The next tier would be “A-B”, which would mean that the fee would be two percent of the loan amount; next would be a “C” grade, or lower credit, which could be a fee of three percent of the loan amount.
The credit grade assigned by the person-to-person lending platform is also used so your lending peers to give them insight into how you manage your debts. The benefit to peer-to-peer loans is that you have the ability to explain why your credit is the way it is. For many peer-to-peer loan borrowers, a well-crafted story is crucial to success. Maybe you’ve fallen on hard times or made mistakes; where a bank may be less likely to listen, person-to-person lending communities will.
How Does Peer to Peer Lending Work for Borrowers?
Every peer lending company has its own process, but in general, they all work pretty similarly. This is how the process works for borrowers:
Answer some questions about your personal financial situation and the type of loan you want. This process will allow the p2p lending platform to run a soft credit check, which will not impact your credit score.
Based on this soft credit score, you will be assigned a loan grade which tells potential lenders how high risk or low risk you are. Based on this grade, they will decide if they want to lend you money. Once enough, investors are willing to fund your loan; the loan will be approved.
A borrower now provides the requested documentation including things like proof and length of employment, total income, and the amount of debt they have if any. All documentation is reviewed for accuracy, and borrowers may need to provide additional information and documents.
Once the loan approval is complete, the finalization documents are sent to the borrower.
Once the forms are signed and returned, the loan money is wired into the borrower’s bank account, usually with two business days.
Nearly all p2p loans can be handled entirely online — no need to go into a bank or even talk to anyone on the phone. The required forms and documents between a borrower and the lending platform can all be sent back and forth via scanning and emails.
Most p2p personal loans are between $2,000 and $35,000, although some offer bigger loans. The loan term is often between three years and five years. Some peer lending companies have an origination fee of 1% to 5% of the loan amount and is deducted from the borrowed funds before the funds are transferred to a borrower.
By registering with a reputable P2P platform, investors could achieve far better returns than standard savings accounts, with potentially less risk than traditional vehicles like property or shares
Types of Loans
Each peer platform lending site offers its own loan products. These are some standard offerings.
Unsecured, (the loan does not require a borrower to provide collateral) fixed-rate personal loans are the bread and butter of most p2p lenders. If your credit score is good enough, you can typically borrow up to $35,000 with a loan term between two and five years. Interest rates (depending on your credit score) generally start in the mid-single digits. Personal loans can be used for anything, including debt consolidation, home improvement projects, and even a car.
If it’s challenging to get a personal loan from a bank, it’s doubly so for business loans. Once again, p2p lenders have stepped up to fill a gap. Four of the biggest peer-to-peer sites, Lending Club, Prosper, Upstart, and Funding Circle, offer business loans. It’s important to form a business structure such as an LLC and start building business credit right away. Upstart only requires that a business be six months old. Banks typically require a business to be at least two years old. P2P lenders usually offer larger business loans than banks. Funding Circle provides loans of up to half a million dollars. Fortunately, there are some websites like llcguys.com that give you some tips on forming and maintaining your legal side of the business. They also have some comprehensive LLC service reviews there as well.
Mortgages and Refinances:
P2P lenders are slowly wading into the mortgage and mortgage refinancing aspects of lending. SoFi, perhaps best known for student loan refinancing, now offers mortgages and mortgage refinancing (not in every state currently), and Lending Club is planning to offer mortgages sometime in the future.
Student Loan Refinancing:
Earnest offers some of the lowest interest rates (as low as 2.27%) and lets you pick a customized payment plan. CommonBond is a more recent player in the field also offering competitive rates.