Peer to Peer Lending

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Peer-to-peer lending is a modern name for an old practice — individuals loaning money directly to acquaintances, family and friends. What’s modern is the technology that now allows perfect strangers to borrow from and lend to each other. Modern peer-to-peer (P2P) lending uses websites to introduce lenders and borrowers. Borrowers create an online profile, go through credit and other checks, and are then chosen (or not) by private lenders who fund the loan. Income and employment may be verified but are not always.

Why bother with peer-to-peer borrowing?

The idea behind P2P lending is that by cutting out intermediaries like banks, investors get higher rates of return, while borrowers pay lower interest rates. P2P loans can be cheaper and should be considered when consumers shop for financing.

One major P2P site claims that during the first seven months of 2014, its borrowers on average reduced their rates from 21.7 percent to 14.8 percent when they consolidated high-interest credit card debt into P2P personal loans. That’s an impressive statistic, but it compares high-interest credit card rates to personal loan rates — not P2P personal loan rates to bank personal loan rates. Borrowers should compare apples to apples when seeking financing for any purpose.

Some borrowers and lenders just prefer the idea of working with an individual instead of a large, faceless company. If they can get a better deal, that’s a bonus.

For these reasons, peer-to-peer lending is becoming increasingly popular — the two biggest P2P sites claim that between them, they originated $2.4 billion in new loans in 2013. The bottom line for consumers is that P2P is another option, and more options and increased competition is good for borrowers.

P2P interest rates

In November of 2014, one large P2P site offered a fixed rate of 6.03 percent for its most creditworthy borrowers and 26.06 percent for its least, with 33 other tiers in between. Another big player has a wider range: from 6.73 percent to 35.36 percent. These scales reflect what individual lenders demand for a given borrower profile to offset their risk. Borrowers should understand that interest rates can change fairly rapidly in response to global economic events, inflation concerns and other factors. This means consumers should compare different loans from a variety of lenders every time they need to borrow.

In addition to the interest payable, the two largest P2P sites charge borrowers a funding or closing fee, typically five percent (the most desirable borrowers pay less), which is normally wrapped into the loan balance.

How easy is it to get approved?

Each P2P site has its own rules and approval criteria, and an application declined by one doesn’t necessarily mean that all the others would reach the same decision. However, the industry-wide denial rate is about 90 percent, says Business Week.. Applying is probably not for the faint of heart.

The floor on credit scores varies from site to site, but the big players tend to exclude those with FICO scores below 640-660, according to a Yahoo! Finance report.

To get the very best rates, applicants need a stellar credit score and a faultless credit report that shows a long and stable history of managing a range of significant accounts. Income and debts are also considered. Applicants who can’t meet those exacting standards should expect to pay a higher rate than top-tier borrowers.

How much can one borrow?

Both the big P2P sites currently cap their personal loans at $35,000, and aren’t interested in lending less than $1,000. Typical loan terms range between three and five years. As with all credit, consumers should borrow as little as possible for as short a time as they can comfortably afford. If a miscalculation is made, it may be possible to take a second loan (concurrent with the first), although naturally, that option is likely to be open only to those with good payment records. If that miscalculation works the other way, and the borrower finds himself better off than anticipated, at least one site allows penalty-free early repayment.

Although the borrower can generally choose the term of the loan, it’s worth noting that lowest rates may be available only for 36-month terms.

P2P vs personal loans

The market for small unsecured loans is highly fragmented, with players ranging from individuals to small local banks to huge national organizations. Any of these sources can offer the best deal — or the worst. It makes sense, then, for those interested in a P2P loan to also compare the offerings of “regular” lenders, including the rate, fees and terms, before committing to a loan.

Peer-to-peer lending can deliver real benefits to borrowers. But, like all credit, it’s a serious business which needs to be carefully thought through in the context of the individual’s financial circumstances.

Shopping for P2P loans

The P2P industry is dominated by two big players, Lending Club (no relation to LendingTree) and Prosper, and they don’t do business in every state. For example, Lending Club does not operate in Idaho or Nebraska, but Prosper does. Prosper does not lend in Maine, Iowa or North Dakota, but Lending Club does. However, new companies are entering the market, and it’s certainly worth including those in any comparison shopping exercise. Consumers should understand that those on the fringe of financial services may not be trustworthy, and should check with the Better Business Bureau and conduct an online search for complaints before making a commitment. Obviously, it’s also essential to fully understand all the loan agreement’s terms and conditions.