What is Peer-to-Peer Lending?
When a borrower is connected with an individual investor — instead of a bank, credit union or online lender — this is called peer-to-peer (P2P) lending.
P2P lending platforms, though not common, can still be a smart choice if you can’t qualify for more traditional financing. P2P lending platforms are also an investing option for everyday people who don’t mind taking on the risk of funding loans.
What is peer-to-peer lending?
Peer-to-peer lending is a form of lending in which individual investors (rather than financial institutions) back the money on a loan. Though commercial or accredited investors with large net worths can fill this role, it’s also possible for everyday retail investors to participate. Most of the time, “P2P lending” refers to connecting borrowers with non-accredited retail investors, though the term can technically cast a wider net.
In either case, an online platform coordinates the administrative process of funding your loan and connecting you to investors. It does this by distributing your loan application to investors, transferring the money to you once your application is accepted and repaying the investors as you pay back your loan.
This method of lending is typically more lenient than applying for funding through traditional avenues, making it a good fit for those who may not be able to qualify at a bank or credit union.
Where to find peer-to-peer loans
Prosper is a well-known P2P lender that has connected 1.7 million borrowers with retail investors since its founding 20 years ago. After Prosper approves your application, investors have 14 days to cover at least 70% of what you need. If they don’t, your loan request will be dropped. However, it’s most common for loans to be funded within one to five days.
To fund loans on Prosper, interested backers must be U.S. permanent residents or citizens, at least 18 years old, have a valid Social Security number or Taxpayer Identification Number and have a checking or savings account. They must also live in a state where Prosper works with investors.
Another lending platform, Upstart, works with accredited investors on a confidential basis. However, accredited investors must meet strict financial criteria (such as a high net worth and income), which differentiates Upstart’s model from Prosper’s.
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How peer-to-peer lending works
While the peer-to-peer lending platforms don’t fund your loan directly, these companies do connect borrowers with investors. Plus, they facilitate the lending process from start to finish. Here’s a closer look at what you can expect:
How do you qualify for peer-to-peer lending?
The exact criteria necessary to qualify for a loan will depend on the peer-to-peer lending platform that you choose to use. That said, the eligibility criteria used will likely be similar to a bank loan and may include, your credit score, employment status, income information and identifying documentation, like your Social Security number (SSN).
In addition to filling out an application, you may be asked to provide the following documents:
- Tax forms, such as W2s or 1099s
- Previous tax returns
- Recent pay stubs
- Recent bank statements
- Copies of your government-issued ID
Since personal loans are unsecured debt, meaning that they do not need to be backed by any collateral, the interest rate that you’re given will depend largely on the strength of your credit profile. Generally, those with good or excellent credit scores are often given the best rates.
How to apply for a peer-to-peer loan
While each peer-to-peer lending platform is unique, the application process generally looks something like this:
- Complete an application: First, you’ll need to fill out an online application with the peer-to-peer lending platform. You’ll have to provide your personal information as well as your income, employment status and credit score. This process generally takes only a few minutes.
- Review your options: Next, you may receive a borrower rating based on your application details and credit score. You typically must also submit qualifying documents, including proof of income. If you qualify for a loan, you’ll have the opportunity to look over the available loan terms and select the best one for you.
- Wait for investor approval: At this stage, you’ll learn if one or more investors are interested in funding your loan or if you were denied a personal loan. If investors commit to funding your loan, you may need to provide additional details regarding your finances, as well as specified documentation to verify your identity, income and employment.
- Sign your loan agreement: If all the information you supplied checks out, your requested loan may be approved. Within a few days, the amount you’re borrowing will be deposited in your bank account. The exact timing depends on your investor and peer-to-peer lending company.
What fees come with peer-to-peer loans?
The most common type of fee on peer-to-peer loans is an origination fee. This fee is typically subtracted from your total loan balance. Amounts can vary, but these fees are generally expressed as a percentage of your total loan amount. The P2P lending platform Prosper, for instance, charges an origination fee of 1.00% - 9.99% on every loan.
You may also be subject to late fees if you do not make your monthly payment on time. Missing payments can also cause your credit score to drop if you’re more than 30 days late as that’s when late payment information is usually reported to the credit bureaus.
How can you use a peer-to-peer loan?
How you can use your loan varies depending on the peer-to-peer platform you use. Typically, companies will outline how you can and cannot use a peer-to-peer loan.
While the purposes of these loans are often flexible, it’s wise to research ahead of time to make sure your intent for your loan aligns with the company’s policies. For instance, some companies may have state restrictions in place.
With all that in mind, there are generally three types of loans that can be funded through a P2P lending platform:
- Personal loans: A personal loan can be used by individuals to fund large purchases, like medical expenses or home improvement projects. They can also be used for debt consolidation.
- Business loans: Business loans are mainly used to cover business expenses, such as providing funding to cover working capital costs or financing equipment purchases.
- Student loans: As the name suggests, student loans are primarily used to finance postsecondary education costs.
Peer-to-peer lending pros and cons
While peer-to-peer loans may prove beneficial for some consumers, it’s not a one-size-fits-all form of credit that will work for everyone. Here’s what to keep in mind as you weigh your options:
Pros
- More lenient qualifying requirements: If you have a low credit score or a thin credit history, you may find it easier to get approved for a bad credit loan, compared to a traditional bank loan.
- More flexibility: P2P lenders may offer more flexibility in loan use than traditional lenders, including for business use
- Few fees: You can typically repay your peer-to-peer loan early without incurring a prepayment penalty, similar to traditional personal loans
Cons
- Longer funding times: It may take longer to get approval and receive your funds with a P2P lending platform since the platform must first approve you and then find an investor willing to fund your loan
- Fewer options: You may have fewer options for lenders than you would find with a more traditional lending scenario.
- State restrictions: P2P loans may not be available in some areas because they don’t have legislation that supports peer-to-peer lending
Frequently asked questions
Whether a peer-to-peer loan is safe depends on the company you use. Before committing to a loan, it’s important to research the company you plan to use to make sure it’s trustworthy. Be sure to check for complaints and regulatory actions with the Consumer Financial Protection Bureau.
You can also check sites such as the Better Business Bureau and Trustpilot to see what other consumers are saying about these companies.
Ultimately, the decision of whether peer-to-peer lending is worth it is a personal one. If you think you may have trouble qualifying for a loan from more traditional sources, applying for a P2P loan may be a good option. However, if you’re a strong borrower, you may be able to find better terms with other lenders.
Even though most P2P lenders have historically allowed individuals to invest in loans, these days, commercial investors largely fill that role. However, some companies may still accept individual investors.
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