How does a peer-to-peer lending system (lending market) work?

May 14, 2019

A peer-to-peer lending company, also known as P2P lending system or social lending, is an online company very similar to the traditional bank lending system, but with a twist: they promise better investments and services. But how can it be?

A peer-to-peer lending company, also known as P2P lending system or social lending, is an online company very similar to the traditional bank lending system, but with a twist: they promise better investments and services. But how can it be?

The P2P lending companies keep things simple. They work as a match maker, connecting investors with people who are in need of money. The match is made using big data technology, one of the reasons they can offer lower fees for their services. They also offer the chance for the investor, the person lending the money, to pick the loans they want to invest. They can also offer the option to invest small amounts of money in different loans to compose a principal, minimizing the investment risks. Because they are online companies, without big physical structures and staff to sustain, they can pay higher returns to the investors and, at the same time, offer a lower interest rate to borrowers.  The P2P lending company gets its share by charging fees from their services.

The 5 biggest P2P systems in the world

1. Upstart

Founded in 2014, they have a $3.4 billion worth in loans and have grown their cashflow three times just in 2017. Their volume of loans is high due to their selection of borrowers: they don’t just considerer FICO scores, they also consider their potential to grow and become a prime borrower. The borrower’s level of education, where they studied and occupation are all inserted in a statistical model to evaluate their capacity of repayment. A personal loan can be from $1,000 up to $50,000.

2. Funding Circle

Focused on business owners, their idea is having business financing business. This way they create a local community for support and financial growth, especially for small business. They are operating in the United Kingdom, United States, Germany and Netherlands.

3. Prosper Marketplace

Also known as Prosper, they offer loans up to $10,000, for low and fixed rates, with payment terms ranging from 3 to 5 years. The option to pre-pay your debit is also available without penalties. You can also check your rates as soon as you fill in your application. They also have a number of specific personal loans you can choose from.

4. CircleBack Lending

They offer cash loans online, with a fast process to find an investor based on your information. You can get a loan for any kind of investment. They have the option of Payday loan, which is a small short-term loan. They offer personal loans till $35,000 and installment loans up to $3,000.

5. Peerform

Peerform is available for US citizens. They match borrowers and investors in a low cost platform, providing a place of investments opportunities and positive experiences for people who needs personal loans. A loan can vary from $4,000 to $25,000 and be paid with fixed rates and an automatic payment system.

Why are P2P loans so popular now?

This system fits the modern age, specially the new generation.  It is simpler, because it basically connects people, and it is online. With the rising of so many new technology based jobs, the idea of future and investments are also changing. Nowadays, we have growing numbers of professionals working online, remotely and outside the usual bound of traditional jobs: there is no contract among workers and the people hiring their services. P2P loans are usually one of many services provided by FINTECH companies.

Today we have a generation able to work anywhere and without traditional bonds.

Today we have a generation able to work anywhere and without traditional bonds.

For a traditional person, it may sound like a crazy idea, but for this new era, it can mean freedom, a possibility to work in different projects of interest and mobility to be anywhere. This new mentality is also applied to investments, and that means looking for different revenues other than what is normally done. Also, growing up alongside with the evolutions of technology, makes it easier to accept the idea of making online investments, looking  for better services, better returns, better fees, a simpler and faster information processing, altogether at the commodity of doing everything from home.

Online solutions: easy and just a click away

Is it the end of banking system?

The P2P services have grown considerable since 2005, after the first platform was founded in the United Kingdom. Working with lending money online, but with better returns for investors and lower interest rates for borrowers, they can be a big problem for the traditional banking system, especially when considering how the world is fast changing with online services and after the financial crises of 2008.

Since the aftermath of 2008, people aren’t so trustful of banks and the way they conduct business. They also want more profits from investments, which is usually lower after the banks get their cuts. To get loans in the traditional banking system is harder and rates are high. All that makes the P2P services very attractive. Perhaps, in the future, they can be a real menace for banks as they are now, if they can’t offer more attractive investments and better options for loans. Especially if the possibility of financing and borrowing for anywhere in the world becomes a reality.

Because P2P lending services also allow investors to get to know the reason for the loan, it can be another option for the microfinance companies. Instead of lending money through an institution, investors can work directly with borrowers. However, since the main users of microfinances are low income business owners or entrepreneurs from developing countries, it can become too much of a risk to invest.

Banks and microfinance companies may be, for now, an only option for people who can’t access internet or don’t have enough income to apply for a loan. But like the traditional financial system, the online finances and the P2P services can become a common option for those looking for investments, loans and banking services, even if you have bad credit history. It is probably a matter of time.

Who can apply for a peer-to-peer loan\services?

Anyone with a minimum credit score and a good credit history can apply. Your income is also an important factor to be eligible to ask a loan, because your debit to income ratio can’t be too high, as a way to ensure you’ll pay your debit in time. So it’s important to make a strong plan to accelerate your debt reduction.

What are the requirements to ask for a P2P loan? How can my application be refused?

To apply for a loan, the companies will ask some basic information to evaluate your application: the loan amount, why do you need the money, if you will have co-applicants, your total income or joint income available... They will check your credit score and based on your information, calculate your interest rate. The exact way they use your information to calculate your rates isn’t clear, but it probably categorize people in good or bad payers. So be sure to fill in your information the best way possible and follow the same advice on how to build a strong loan application.

Some P2P companies will let you know your interest rate as soon as you fill in your information

One of the reasons people choose a P2P lending platform is the better chance of being approved for the loan, due to the low amount of applicants. But it can be a double-edged sword: with less people to process, the company will take a very careful look at your application, why you are asking a loan, and check your credit worthiness as a borrower.

Although P2P companies works differently, it is a good idea to check for older debits and pay them off first. Since your income will be considered for approval, be sure to include all side incomes you may have. It will guaranty a minimal level of funding to pay your debt, which is considered by the investors. Remember, the P2P system doesn’t offer insurance for investors, they just match people. That is why some companies will dig deep before they approve applications.

Crafts and art can be a good source of additional income

They will also consider your reasons for asking a loan, so it is best not asking all you can, but all you need. Not only it will help you to be approved, it will also ensure you’ll be able to pay your loan on time. It is also an option to have a longer term to pay your loan in order to have a lower interest rate. Being able to pay your loan without delays is always seen as a good sign to get your approval. 

But be aware of schemers: if a company asks for gift cards, or any money advantage without previous disclaimer, you better check if you’re not dealing with a suspicious company. Most serious P2P lending companies charge fees related with their services, so be aware!

Who are the lenders of this system? How can people become one?

The lenders are people looking for investments, specially investments with better rates of interest.  Since the P2P system doesn’t charge for a number of fees as normal banks, and also don’t offer security for investors, they offer better rates to both sides: investors and borrowers. Although those companies work following the same basic principle, it is a good idea to read their terms carefully, such as how their fee structure works, what are their rates and how their eligibility for borrowers works.

To become an investor or lender, you need to choose a P2P company first, since their requirements may vary. Overall, you have to be at least 18 years old and have your identification verified. Some may ask you to be resident of a specific country and have a bank account in that country as well. After that, you transfer an amount of money to the platform and it will be borrowed by other people. Some companies may require a minimum initial deposit and also allow you to be an individual investor, use trust funds, a corporate account or joint accounts. Be sure to check the availability of those services.

After that, you can choose the criteria to whom the company can lend your money, or to how many people. Some may offer you the opportunity personally pick loans of their list of options, or just select the criteria of what loans you want to invest, so their system picks the loans based on that.

A P2P system you can choose to whom you will lend your money

To ensure lower fees and better returns, the P2P system doesn’t have the same safeguards as traditional banks. Because of that, before you become an investor, it is interesting to check if the company you want to join have public data information you can access, like the quality and performance of their loan system.  A P2P system is a high-risk investment, so be aware of those risks before you invest. It is also import to check how the platform will lend your money: can you spread your investment among different borrowers or do you need to invest in just one person? What are the minimum amount per person you can invest and how long does it take to be paid back?

A good investment strategy can be worth a passive income of over 10% of your investment after a year. An example would be lending a $10.000,00 and get $1.000,00 profit. But it will depend on the type of loans you choose to invest, and their risks, since there is always the chance you won’t be paid back.

What happens if the borrower doesn’t pay? What can be done? What are the risks?

When becoming an investor, it is important to check alongside the interest rates, the risk of the borrowers you lend money. The higher the interest rate, the higher is the risk of that borrower. So what to do when they don’t pay?

Don’t stress! There are ways to get your money back.

The P2P company will try to reach the borrower and ask about the payments. If it doesn’t work, they will contact external collecting agencies to find and return as much as possible back to the investor. In less extreme cases, the P2P company will reach the borrower and try to work a payment plan. Those borrowers will also have their credit score impacted, making it difficult for them to have future credit. Some companies may also disqualify that person for future loans in the platform.

The risk of having loans not paid off is a reality, and must be taken in consideration when becoming an investor. Have in mind the collecting agencies will also charge fees, so it is unlikely you’ll have the original amount lent back. It is important to check the options of have in the platform to build a diverse portfolio of investments, as a way to lower the impact of the loans you don’t get paid back. Be sure to balance your risks and gains.

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