July 23, 2024

What Is Peer-To-Peer (P2P) Lending & How It Works?

Banks, online lenders, credit unions, same-day pay apps — there are dozens of ways to access money when you need it. But when you need money fast, there can be certain advantages to having another human help you out.

Where borrowers and lenders converge in the digital marketplace, you’ll find an intriguing new way to borrow money: peer-to-peer (P2P) lending. Discover the ins and outs of this lending approach to determine whether it’s the right one for you.

What’s peer-to-peer lending?

P2P lending bypasses traditional financial institutions like banks and credit unions, letting people borrow directly from other people. The result is often a win-win: Borrowers get low interest rates and flexible repayments, while lenders make a profit. It’s no wonder this approach is so popular, with a global market value of roughly $200 billion.

How does peer-to-peer lending work?

This lending method occurs via online P2P lending platforms like Upstart, LendingClub, and Prosper. On these sites, borrowers create loan listings, specifying the amount they want to borrow and the purpose of the loan. Investors and lenders browse these listings, choosing which loans to fund based on factors like risk and potential return.

Platforms typically consider the following criteria when accepting users:

Credit score
Income
Debt-to-income ratio (for borrowers)
Investment limit (for lenders)

If funded, borrowers receive loans and repay investors, including interest, through the P2P platform. These platforms make money by charging loan origination and servicing fees.

Benefits of peer-to-peer lending

Here are a few notable advantages of P2P lending:

1. Easier to qualify with no credit

When evaluating loan applications, P2P lending platforms often consider factors beyond traditional credit scores. This means individuals with limited credit history or lower scores may still qualify for loans based on other criteria like income, employment status, and debt-to-income ratio. P2P lending is perfect for people who can’t get a traditional loan.

2. Greater flexibility

P2P lending gives borrowers greater flexibility in terms of loan amounts, repayment periods, and interest rates compared to traditional lending sources. Borrowers can choose from loan options tailored to their specific financial needs and preferences, allowing for more customized borrowing experiences.

These platforms also often offer flexible repayment terms, including the ability to make early repayments without penalty, providing borrowers with greater control over their loan repayment schedules.

3. Lower fees

P2P lending typically involves lower fees and overhead costs than traditional banking services, reducing borrowing costs. While traditional financial institutions may charge processing fees and prepayment penalties, P2P lending platforms typically have streamlined fee structures with fewer hidden charges.

This transparency ensures borrowers know the total cost of the loan from the beginning, encouraging more informed decision-making and saving them money in the loan term.

Risks of peer-to-peer lending

Generally, peer-to-peer lending is safe. But borrowers should consider these drawbacks before deciding if it’s the right approach:

1. Fewer options

While P2P lending offers alternative financing options, borrowers may find fewer loan products and features than traditional banks and credit unions. For instance, P2P lending platforms may have limited loan offerings tailored to specific industries or loan purposes, restricting borrowers' choices and flexibility.

2. Approval can take longer

Unlike traditional lending institutions that may offer expedited loan approval processes, P2P lending platforms sometimes take longer to process applications. The P2P lending model involves multiple steps, including borrower verification, investor funding, and loan underwriting, which can prolong the approval timeline.

As a result, borrowers seeking immediate access to funds or time-sensitive financing may not get the money they need in time, impacting their ability to meet urgent financial needs.

3. Not available in all states

P2P lending operates under regulatory frameworks that vary by area, which means some lending platforms can’t operate in certain states. People in states where P2P lending isn’t available may need to explore alternative financing options or seek out-of-state lenders, adding complexity to the borrowing process and potentially limiting their choices.

5 types of peer-to-peer loans

Here are common types of P2P loans you can get via popular lending platforms.

1. Personal loans

Here, individuals seek funds for purposes such as debt consolidation, home improvement, and unexpected expenses. Borrowers typically receive fixed-term loans with competitive interest rates based on their creditworthiness.

2. Car loans

P2P platforms also facilitate auto loans, allowing borrowers to finance a car or other vehicle. These loans may offer favorable terms and rates compared with traditional auto financing options, making them attractive for borrowers seeking affordable loans.

3. Business loans

Small business owners can use P2P lending to gain venture financing. P2P business loans may cover startup capital, expansion, or equipment acquisition. They often feature flexible terms and streamlined application processes, making them suitable for busy entrepreneurs with ever-changing funding needs.

4. Student loans

P2P lending platforms also offer student loans to individuals seeking financing for tuition fees, textbooks, and living expenses. These loans often provide competitive interest rates and flexible repayment options, outclassing products from more traditional lenders like banks and governments.

5. Medical loans

Medical loans help people cover healthcare expenses like elective surgeries, dental procedures, and medical emergencies. These loans offer borrowers an alternative to traditional healthcare financing options and may provide faster funding with fewer restrictions, ensuring access to desired (or essential) medical treatments with little delay.

So, when’s a good time to seek a peer-to-peer loan?

Bear in mind that taking out a P2P loan without a clear repayment plan, or using one to fund discretionary expenses, could lead to financial strain. Exercise caution and borrow responsibly to avoid falling into a cycle of debt.

It’s also worth asking if you’ve considered all your options. Alternative financing sources like traditional bank loans, credit card cash advances, and personal lines of credit could better fit your financial needs and preferences.

If you’re set on P2P loans, here are a couple of optimal scenarios for this lending style:

Debt consolidation

If you have multiple high-interest debts, like credit card balances or personal loans, consolidate them into a single P2P loan with a lower interest rate. This could save you money on interest payments and simplify your debt repayment strategy.

Small business financing

Entrepreneurs and small business owners may find P2P lending platforms a viable funding source for business expansion, inventory purchases, or working capital needs. Some platforms offer faster approval processes and more lenient eligibility criteria than traditional bank or credit union loans, making them accessible to startups and businesses with limited operating history or credit history.

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Get the money you need, avoid the loan headaches, and make moves toward a brighter financial future with EarnIn.

Please note the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.

1. EarnIn is a financial technology company, not a bank. Banking Services are provided by Evolve Bank & Trust, Member FDIC. Subject to your available earnings, Daily Max, and Pay Period Max. EarnIn does not charge interest on Cash Outs. EarnIn does not charge membership fees for use of its services. Fees and restrictions apply to use Lightning Speed. Lightning Speed may not be available at all times. See Cash Out User Agreement. Expedited Transfer fees paid up front where applicable - see Evolve Deposit Account Agreement. EarnIn services may not be available in all states. Restrictions and/or third party fees may apply, see EarnIn.com/TOS for details.