Peer-To-Peer Lending (P2P)

Peer-to-peer (P2P) lending enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman. Websites that facilitate peer-to-peer lending have greatly increased its adoption as an alternative method of financing.

P2P lending is also known as social lending or crowdlending. It has only existed since 2005 but the crowd of competitors already includes Prosper, Lending Club, Peerform, Upstart, and StreetShares.

[Important: Any consumer or investor considering using a peer-to-peer lending site should check the fees on transactions.]

P2P lending websites connect borrowers directly to investors. The site sets the rates and the terms and enables the transaction. Most sites have a wide range of interest rates based on the creditworthiness of the applicant.

An investor opens an account with the site and deposits a sum of money to be dispersed in loans. The loan applicant posts a financial profile that is assigned a risk category that determines the interest rate the applicant will pay. The loan applicant can review offers and accept one. (Some applicants break up their requests into chunks and accept multiple offers.) The money transfer and the monthly payments are handled through the platform.

The process can be entirely automated or lenders and borrowers can choose to haggle.

Some sites specialize in particular types of borrowers. StreetShares is designed for small businesses. Lending Club has a "Patient Solutions" category that links doctors who offer financing programs with prospective patients.

How P2P Lending Evolved

Early on, the P2P lending system was seen as offering credit access to people who would be spurned by conventional institutions, or a way to consolidate student loan debt at a more favorable interest rate. In recent years, however, peer-to-peer lending sites have expanded their reach. Most now target consumers who want to pay off credit card debt at a lower interest rate. Home improvement loans and auto financing are now available at peer-to-peer lending sites.

The rates for applicants with good credit are often lower than comparable bank rates. Rates for applicants with sketchy credit records may go much higher. For example, LendingTree.com offered rates from 6.95% to 35.80% as of the end of April 2019. Peerform posted rates at a range of 5.99% to 29.99%.

The average credit card interest rate was 17.67% as of March 27, 2019.

For lenders, peer-to-peer lending is a way to generate interest income on their cash at a rate that exceeds those offered by conventional savings accounts or certificates of deposit (CD). Some sites allow lenders to start with an account balance of as little as $25.

Peer-to-peer lending is controversial. An analysis by the Cleveland Federal Reserve in 2017 warned that consumer lending through peer-to-peer sites was beginning to resemble the subprime mortgage lending system that caused the 2008 financial crisis. That is, as the sites expanded their reach they began loosening their standards, leading to higher default rates.

It also had a warning for consumers: People who consolidate consumer debt through peer-to-peer lending sites tend to wind up with even more overall debt when they begin to use credit cards freed up by their loans.

It noted that nearly 16 million American consumers had personal loans through peer-to-peer lending sites by the end of 2016.

A Warning for Investors

People who are considering joining a peer-to-peer lending site as investors need to worry about default rates, as do conventional banks. Zopa had a default rate of 4.52% for loans granted in 2017, according to a UK-based business blog. It said that other sites were forecasting similar default rates. An S&P/Experian composite index of default rates across all types of lending to U.S. borrowers has been fluctuating between about 0.8% and 1% since April 2015. The default rate on U.S. credit card debt fluctuates much more, hitting a high of 9.1% in April 2015 but dropping to 3.56% in mid-2018.

Any consumer or investor considering using a peer-to-peer lending site should check the fees on transactions. Every site makes money differently, but fees and commissions may be charged the lender, the borrower, or both. Like banks, the sites may charge loan origination fees, late fees, and bounced-payment fees.

• P2P lending websites connect borrowers directly to investors. The site sets the rates and terms and enables the transaction.
• P2P lenders are individual investors who want to get a better return on their cash savings than a bank savings account or CD offers.
• P2P borrowers seek an alternative to traditional banks or a better rate than banks offer.