Peer to Peer Lending, or P2P lending, is lending that takes place between individuals, and bypasses the traditional role of borrowing money from a bank or lending money to a bank in the form of CDs or deposits. Why do this? Simple – because there is a lot of money involved and a lot of people want in on the action. Peer to peer lending allows “regular Joe’s” the opportunity to play the role of the banker and assume the same risks – and rewards.
How does peer to peer lending work?
Peer to peer lending involves a borrower submitting a loan application, and lenders bidding to fund the loan. In the case of Prosper, a borrower first applies for a loan. Then their credit risk and other factors are considered and posted for lenders to search and bid on the loans if they choose. When there are enough lenders to fund the loan, Prosper loans the borrower the money, then sells portions of the loan to the lenders. Lenders are actually buying a piece of the loan, not making the loan. Since you can buy into a loan for as low as $50, it is easy to mitigate risk by diversifying over several loans. The process may vary slightly between different P2P lending companies, but the principle is similar.
Here is a CBS video that explains P2P lending:
Who benefits with peer to peer lending?
Everyone benefits with peer to peer lending, as long as everything goes as advertised.
Borrowers benefit because they are able to get a loan, often at a lower rate than they would have been able to get at a bank. Loans can often be made at better rates to borrowers because there are fewer overhead costs associated with the loan.
Lenders benefit because they will often receive higher returns on their money than had they placed their funds into a CD. Returns of 9-12% are not uncommon, however, your exact results may vary. Peer to peer lending companies such as Prosper or Lending Club benefit because they take a small percentage of the originating loan cost.
Is peer to peer lending safe?
The P2P lending process is safe, but as with making any loan, peer to peer lending involves a certain amount of risk. The best way to mitigate this risk is to fully research the credit rates assigned by the P2P companies, and diversify your funds across several loans. Since you can bid with as little as $50, it is very easy to diversify your money. If you go with a reputable company, such as Prosper or Lending Club, you are essentially assuming the same amount of risk a bank would, just on a smaller scale.
Which companies offer peer to peer lending?
There are actually quite a few companies around the globe that offer P2P lending. The most prominent peer to peer lenders in the US include:
- Lending Club
- Pertuity Direct
- Kiva (Kiva offers loans to people in 3rd world countries; lenders only receive their principle back, but do not earn interest. This is seen mostly as doing something good with your money and giving people an opportunity they may not have otherwise had).
Why participate in peer to peer lending?
The reasons differ for borrowers and lenders. Borrowing through a peer to peer company often allows borrowers to get a loan at a lower rate than through a bank, or get a loan when a bank would not give them one. For lenders, peer to peer lending allows you to “be the bank.” When you make loans or buy a portion of a preexisting loan, you are offering someone money and getting paid for taking on the risk of doing so. Lenders also have the chance to diversify their money over many loans which creates multiple streams of income. As the loans get repaid, the lender has the option of lending the money in new loans or withdrawing the money.
Does it take a lot of money to get started?
No. In most cases, you can start lending for as little as $50, which allows you to make small investments, but also diversify your loans across several borrowers and risk classes. This helps to lower the risk involved in any one loan not being repaid and destroying your entire investment.
How much money can you make with peer to peer lending?
This varies depending on the loans you purchase, the risk involved, and many other factors. Some of the P2P lending companies offer plans that are already diversified and offer a “target” return. There is no guarantee the return will actually meet the target, but it is designed to get you there. Prosper is currently advertising average lender returns around 9-12%. Of course, your outcome may differ depending on your portfolio and what happens with each loan. Just remember – there is no guarantee with these loans. But that is precisely why they offer better returns than a guaranteed investment such as a CD. Lenders are rewarded for taking the risk.
Should I invest in peer to peer lending?
Aha! I can’t answer that one for you! I can tell you though, that just like everything else, you need to consider your total asset allocation and you ability to deal with risk.