What is Peer-to-Peer Lending?

Person-to-Person. Peer-to-Peer. P2P. Social Lending.

Whatever term you use, the concept is the same. Lenders and borrowers coming together without the assistance of a banking institution.

How does peer-to-peer lending work?

Investors: Individuals who are looking to invest their money into small loans sign up with sites like Prosper, Lending Tree, or Lending Club. Once signed up, investors will need to fund their account with as much money as they find appropriate. The minimum can be as small as $25. The decision on how much to invest is completely up to each investor.

Borrowers: Individuals who are looking to acquire a loan will sign up and answer questions about their credit score, employment status, income, and more. Once they have completed the sign-up, the borrow now creates a request for a loan. The next step is to wait for funding from interested investors.

What are the benefits?

Investors: The benefits of P2P lending include a higher rate of return. Prosper claims that investors have experienced seasoned returns of 10.46%. This is definitely higher than a return on your investment in other traditional investments. I have read investor claims stating their actual return has ranged from 8% to 12%. Investors also have more control over how much they will invest with the loans that they select. Additionally, a benefit of P2P lending is further diversification of your investment portfolio.

Borrowers: The benefit of P2P lending for the borrower lies in their ability to secure a loan when they might not otherwise be able to do so. Borrowers go to social lending sites when traditional banks deny approving their loan applications. The rates are often lower than what they would be offered from a bank as well.

Are there risks involved?

Investors: As with any loan, the risk involved includes loan defaults. This is an area that an investor will need to consider and factor into their investment funds. However, the investor is in charge of how much they invest in each loan so the risk can be lessened by the amount you lend out. Only risk as much as you are willing to lose.

Borrowers: The loan duration usually ranges from short-term to longer-term (60 months). A borrower could find themselves with a higher payment than they can afford if they haven’t done proper calculations.

The choice to invest with social lending is up to each individual but with the ability to risk little money with each loan that you fund, using sites like Prosper or Lending Tree can bring a larger than average return on your investment. Directly helping a person may also be an added benefit that traditional investments do not allow for.