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What is Peer-to-Peer lending?

Understanding P2P Lending

Peer-to peer (P2P) Lending

Special Considerations

Peer-to-Peer Lending Q&As

Personal Loans, Lending

What is Peer-toPeer (P2P) lending? The definition and the way it operates

By Julia Kagan

Updated December 20 20, 2022

Written by Thomas J. Catalano

Facts checked by Amanda Bellucco-Chatham

What is Peer-toPeer (P2P) lending?

Peer-to peer (P2P) lending allows people to get loans directly from others, cutting out banks as a middleman. Websites that support P2P lending have significantly grown in popularity as an alternative way of financing.

P2P lending can also be referred to by the name of “social lending” or “crowd lending.” It has only been available since, but the crowd of rivals already includes Prosper, Lending Club, Upstart, and StreetShares.

The most important takeaways

Peer-to peer (P2P) loan is one type of technology for financial transactions that allows people to loan or take cash from another, without having to go through a bank.

P2P lending sites allow borrowers to connect directly with investors. The site sets the rates and conditions, and allows the transactions.

P2P lenders are individuals who wish to receive a better return on their savings in cash than they would get from a savings account at a bank or certificate of deposit.

P2P borrowers are looking for alternatives to traditional banks or a lower interest rate.

In the case of P2P loans, default rate loans are much higher than the default rates for traditional finance.

Understanding Peer-to-Peer Lending

P2P loan websites link borrowers to lenders. Each website sets the rates and the terms and enables the loan. Most sites have a wide range of interest rates depending on the creditworthiness the person applying.

An investor creates an account with the website and deposits a sum of funds to be distributed in loans. The loan applicant creates an financial profile which is assigned a risk classification which determines the rate of interest the borrower will be charged. The loan applicant is able to review the offers and choose to accept one. (Some applicants split their requests into smaller chunks and take multiple offers.) The money transfer as well as the monthly payments are processed through the platform. The process can be completely automated, and lenders as well as customers can decide to haggle.

Certain websites specialize in specific types of borrowers. StreetShares, for example, is specifically designed for small businesses.1 Furthermore, Lending Club has a “Patient Solutions” category that connects physicians who provide financing programs to prospective patients.2

History of Peer-to-Peer (P2P) Lending

At first the P2P credit system was viewed as a way to provide credit to those who would be spurned by conventional institutions or an opportunity to combine student loan debt at a more favorable interest rate.

In recent times however, P2P lending sites have expanded their reach. The majority of them target customers who are looking to pay off credit card debt with a lower interest rate. Home improvement loans or auto loans are also available on P2P lending websites.

The rates for applicants with good credit tend to be less than similar bank rates, whereas rates for those with poor credit histories could be higher. LendingTree.com, for example, offered personal loan rates ranging from 5.99% to 35.99 percent as of December. 15, 2022.3 Peerform posted loan rates with a range from 5.99% to 29.99%.4 The average credit card interest rate was 19.59 percent as of Dec. 14th, 2022, according to CreditCards.com.5

for lenders P2P lending is a way to generate interest income from their funds at rates higher than the rates offered by traditional bank savings or certificate of deposit (CDs).

Some P2P sites let lenders begin with a balance of as little as $25.

Special Considerations

Individuals who want to lend money through a P2P lending site should be aware that their borrowers will default on their loans like conventional banks do. Studies on P2P loan platforms have shown that defaults are much more frequent than those faced by traditional financial institutions, with some exceeding 10%.6

The average of S&P/Experian’s composite of default rate for all kinds of loans for U.S. borrowers has fallen from 1.55% to 0.59% over the ten years prior to November of 2022.7

Anyone who is looking at a P2P lending website must also look into the fees for transactions. Each site earns money in a different way however, fees and commissions could be charged at the expense of the borrower, the lender the borrower, or both. As banks do, websites may charge loan origination fees, late fees, and bounced-payment fees.

Is peer-to-peer lending (P2P) safe?

Peer-to-peer lending is riskier than the savings account or certificate of deposit, but the rates of interest are typically more expensive. This is because people that invest on a peer-to -peer lending site assume most of the risk. This is typically assumed by banks or different financial institutions.

How big is this market of peer-to-peer (P2P) lending?

The market for peer-to peer lending was valued at $83.79 billion by 2021, according to data from Precedence Research. The market is expected to reach $705.81 billion in 2030.8

How can you invest in peer-to-peer lending?

The simplest method of investing in peer-to peer lending is to create an account with a P2P lending site and begin lending money to customers. These websites typically permit the lender to select the characteristics of their borrowers and allow them to choose between high risk/high return or lower returns. Alternatively some P2P lending sites are public companies, so one can also invest in them by buying their shares.

KAS

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