What is peer-to-peer (P2P) lending?Peer-to-peer (P2P) lending, also referred to as marketplace lending, is a type of lending that uses online platform
What is peer-to-peer (P2P) lending?
Peer-to-peer (P2P) lending, also referred to as marketplace lending, is a type of lending that uses online platforms to link lenders and borrowers directly, eliminating the use of conventional financial intermediaries, such as banks.
In P2P lending, individuals or businesses seeking loans can request funding by creating loan listings on a P2P platform. Individual investors or institutional lenders, on the other hand, can analyze these listings and decide to fund them based on their level of risk tolerance and expected rate of return.
P2P lending platforms serve as intermediaries, enabling the loan application, credit evaluation and loan servicing processes. They leverage technology to improve the user experience and pair lenders and borrowers. The loans may be used for a variety of things, including debt consolidation, small company loans, school loans and personal loans.
P2P lending platforms function within the legal restrictions imposed by the country in which they are based. Platforms must abide by all applicable laws, particularly those relating to borrower and investor protection, which differ depending on the country’s regulations.
Examples of P2P lending platforms
LendingClub is one of the largest P2P lending platforms in the United States. It offers personal loans, business loans and auto refinancing options. Zopa is another prominent P2P lending platform in the United Kingdom. It offers personal loans and investments, connecting borrowers and investors directly.
Aave is a decentralized P2P lending platform on the Ethereum blockchain that enables users to lend and borrow cryptocurrencies at interest rates that are based on supply and demand dynamics. It provides a wide range of features, including incentives for liquidity mining, flash loans and collateralized borrowing.
How does P2P lending work?
Let’s understand the P2P lending process using an example. Say Bob wants to borrow $10,000 to consolidate his debt. On a P2P lending platform, he submits a loan application and includes his financial details and loan justification. After evaluating John’s creditworthiness, the platform lists his loan.
A platform user named Alice reads John’s loan listing and decides to fund $1,000 of the loan because she thinks it fits with her investment philosophy. As additional lenders follow suit, Bob receives the $10,000 when the loan has been fully funded. The P2P lending network disperses Bob’s monthly repayments, which include principal and interest, among the lenders over time. Bob pays interest, which gives Alice and other lenders a return on their investment.
The step-by-step process of P2P pending between Bob and Alice is explained below:
- Bob submits an application for a $10,000 loan for debt consolidation on a P2P lending website.
- Based on Bob’s financial information and loan purpose, the P2P lending platform evaluates his creditworthiness.
- The platform lists Bob’s loan request along with information about the amount, annual percentage rate and purpose of the loan.
- Following an examination of the various loan listings, Alice, a platform investor, chooses to contribute $1,000 to Bob’s loan.
- Bob receives the $10,000 loan amount after additional lenders have fully funded the loan.
- Bob pays the P2P lending platform a certain amount each month in principal and interest.
- The P2P lending network collects Bob’s repayments and then distributes them to other lenders, such as Alice.
- Through the interest payments made by Bob over time, Alice and the other lenders make money on their investments.
Related: What is P2P trading, and how does it work on peer-to-peer crypto exchanges?
Secured vs. unsecured P2P lending
Secured and unsecured P2P lending are two distinct approaches to lending in the context of peer-to-peer platforms. Secured P2P lending refers to loans backed by assets, such as traditional ones like real estate or cars, as well as digital ones like cryptocurrency, as collateral. When a borrower defaults, the lender can seize and sell the collateral to recover their funds.
On the other hand, unsecured P2P lending does not require collateral. Lenders base their risk evaluation on the borrower’s creditworthiness and financial background. In cases of default, lenders often turn to legal procedures for debt recovery as they have no specific assets to seize in the event of a default.
The P2P platform’s collateral policies, interest rates and risks must be carefully considered by both borrowers and lenders when considering offering an unsecured loan.
How to become a peer-to-peer lender
Find a P2P lending platform that fits your investment preferences before applying to become a peer-to-peer lender. Choose platforms with a solid reputation, clear pricing arrangements and a history of effective loan transactions. Additionally, users should become familiar with the P2P lending regulations in their country since there may be certain requirements or licensing procedures to…
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