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Updated onSeptember 18, 2022

What Is Peer To Peer Lending?

8 Min  Read
Difficulty:moderate
Paige Cerulli
Written by:Paige Cerulli
Business Content Writer

Reviewed by: Kal Salem, MA Accounting - Arizona State University

Fact-checked by: Somer G. Anderson, PhD Finance - Maryville University

What Is Peer To Peer Lending
All content presented here and elsewhere is solely intended for informational purposes only. The reader is required to seek professional counsel before beginning any legal or financial endeavor.

What is peer-to-peer lending, exactly? Online peer-to-peer loan platforms connect borrowers directly to investors without using a bank or a credit union. Investors fund loan requests and may get a better return on their money than loaning it through a bank. Less rigorous loan eligibility requirements make P2P loans appealing for many borrowers, too.

Exploring new lending and investing opportunities can be intimidating. These tips can help you to stay focused and make the most of P2P lending.

Evaluate Your Financial Health. Before you consider lending or investing, take some time to evaluate your financial health. Knowing where you stand can help you to make wise financial decisions.

Be Open. Peer-to-peer lending is a lesser-known option, but it offers some benefits when compared to traditional loans. Stay open and explore this new option to see if it’s right for you.

Consider How Comfortable You Are with Risk. Any sort of lending or investing carries some degree of risk. Think about how much risk you’re comfortable taking on and look for opportunities that fall within that comfort zone.

Focus on the Details. Whether lending or borrowing, it’s important to understand all of the details of P2P loans. Take your time, do your research, and make the decision that’s right for your financial situation.

How Does Peer-to-Peer Lending Work?

What is peer-to-peer lending and how does it work? P2P lenders first need to register with an online platform. Registered lenders can review information on each loan listing’s amount, risk, and potential return to decide which listing(s) they would like to fund. The platform processes payments and lenders gradually receive their funds, plus interest, back.

Borrowers must complete several steps:

  • Prequalification: The lending site gathers some basic borrower information and performs a soft credit check to see if the borrower is eligible. The site gives the borrower estimated loan terms and APR rates.
  • Application: If a borrower qualifies, they can submit a hard application, and the lender will perform a hard credit check
  • Approval: The lender will approve or deny the borrower.
  • Funding: Approved loan requests are posted on the lender’s site, and investors can review and choose to fund the loan. Multiple investors might work together to fund larger loans.
  • Transfer of Funds: Once loans are funded, those funds are electronically transferred to a borrower’s bank account.
  • Loan Payments: Borrowers make monthly loan payments to the lending site. The site distributes those payments to the funders.

Who Is Peer-to-Peer Lending Recommended For?

Peer-to-peer loans are versatile and can be used for many purposes. They’re suitable for small business owners who need funding to start or grow a business. Borrowers can also use P2P loans for personal costs, like home improvement projects, debt consolidation, medical expenses, travel expenses, or car repairs.

Peer-to-peer lending is recommended for several types of borrowers:

  • Borrowers who don’t qualify for traditional loans because of issues like bad credit
  • Borrowers who have good credit but who are looking for lower interest rates than traditional loans offer
  • Small business owners who want to avoid long, complicated funding processes
  • Borrowers who need money quickly
  • Entrepreneurs who are starting a business and who don’t have the business history to qualify for a traditional business loan, you might also want to explore what is crowdfunding

Where To Look for Peer-to-Peer Loans?

Online lenders Prosper and Upstart offer unsecured personal loans and are highly popular P2P platforms. If you’re looking for peer to peer lending for business, consider Funding Circle and StreetShares, which specialize in small business loans. The right P2P site for your needs will depend on your desired funding amount, how you plan to use the funding, and how savvy you are with the P2P process.

When looking for P2P loans, consider the following questions:

  • What type of funding does this P2P website offer, and what are the loan terms and restrictions?
  • How long has this website been operating and how much guidance does it provide to new borrowers?
  • What are the customer reviews saying about this website?

Pros And Cons Of Taking A Peer-to-Peer Loan

Pros:

Quick lending process: P2P loan applications take just a few minutes to complete, but loan applications through banks and credit unions are often more involved and time-consuming.
Peer to peer funding for bad credit: P2P loans have more flexible terms
Fast access to cash: Most P2P loans are funded in just a few days. It can be a week or more before you receive traditional loan funding.
Higher returns to investors: Compared to traditional loans, P2P loans often give investors higher returns on their investments.

Cons

Higher risk: Since borrowers with lower credit scores may be approved for P2P loans, there’s a higher chance of the borrower defaulting on the loan. Lenders need to be aware of this risk when deciding to fund a P2P loan.
No insurance or government protection: A lender’s P2P investments aren’t FDIC insured, so if the borrower defaults on the loan, the lender might not get their money back.
High interest rates: Each P2P platform sets its interest rates. Depending on the platform and a borrower’s credit rating, P2P interest rates could be higher than a traditional loan’s interest rates.
Can affect credit score: The hard credit inquiry of a P2P application can slightly lower a borrower’s credit score. If borrowers miss payment deadlines, their score may drop.
Additional fees: Many P2P lenders charge origination fees in addition to interest. According to Bankrate, origination fees can range from one to eight percent of the loan, which can increase the amount that the borrower has to repay.

Peer-to-Peer Vs Traditional Loans - What Is Better for Your Small Business?

Whether a peer-to-peer or traditional loan is right for your business will depend on your credit score and how quickly you need the funding. If you don’t qualify for a traditional loan because of poor credit or because your business is too new, a P2P loan can be a good alternative that lets you quickly and easily get funding. But if you have poor credit, you could pay higher interest rates for a P2P loan than a traditional loan.

  • Traditional loans can have strict eligibility requirements, and the funding process can take weeks. Business owners with strong credit and an established business history may get better interest rates with a traditional loan. You might wish to start by looking into what is a microloan.
  • P2P business loans can be ideal for business owners who want a simple application process and who need funding quickly. They can help business owners with poor credit get funding, and business owners with strong credit might find a P2P loan offers the best interest rates. These loans are suitable for both startups and established businesses.

To explore all of your options, check out this article on the best small business loans.

I Want to Invest in Peer-to-Peer Loans - Is It Safe?

If you want to invest a small amount of money, peer-to-peer loans can be a good investment. You can use P2P loans to diversify your portfolio, and since you can choose funding opportunities based on the borrower’s credit score, you can minimize your risk. But is peer-to-peer lending safe? There are some risks involved, and since P2P loans aren’t government-protected, there’s no guarantee you’ll get your money back.

Peer-to-peer investing may be right for you if you:

  • Want to invest small amounts of money and losing that money won’t harm your finances
  • Want a more hands-on investment opportunity that lets you select the funding requests you invest in
  • Understand that P2P platforms charge earning fees that will reduce your profits

Conclusion

What is peer-to-peer lending? It’s an alternative to traditional funding that benefits borrowers and lenders. If you want to invest small amounts of money, you can pick and fund P2P loans and might see greater returns. If you need funding quickly or have found that traditional bank loans aren’t right for you, P2P loans might be a better fit. Fees and policies vary across P2P platforms, so whether you want to borrow or invest, carefully research each platform.

About the Authors

Paige Cerulli

Written by: Paige Cerulli

Business Content Writer
500+

Paige Cerulli is a content writer and copywriter who specializes in business, finance, pet, and health topics. An entrepreneur herself, Paige enjoys writing about topics that help business owners to make well-informed strategic decisions.

More about me
500+
Kal Salem

Reviewed by: Kal Salem

CPA, PMP and Finance Consultant

A CPA and finance professional working with small businesses to educate owners and grow alongside their businesses. He holds a Masters in Accounting and a BS in Supply Chain Management. Owner at Salem CPA Services LLC.

More about me
Somer G. Anderson, Ph.D.

Fact checked by: Somer G. Anderson Ph.D., CPA

Accounting and Finance Professor
500+

Somer G. Anderson has been working in the Accounting and Finance industries for over 20 years as a financial statement auditor, a finance manager in a large healthcare organization, and a Finance and Accounting professor at Maryville University.

More about me
500+

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