Peer-to-Peer (“P2P”) lending is a method that matches individuals who want to lend or borrow from one another without the use of a traditional financial institution. Basically, you can lend your own money to someone and earn interest, sometimes as high as 10% or more. Conversely, you can borrow money directly from investors, cutting the middleman. Popular online platforms include Lending Club or Prosper.
Before you decide to lend money to or borrow money from a stranger online, here’s what you need to know first.
Benefits and Risks for Lenders
Lenders decide how much money they want to invest, the level of risk they are willing to take, and the term of the loan. They can browse listings and select which loans to fund based on criteria such as the purpose of the loan, interest rate, and borrower’s credit profile. According to Lending Club, their lenders have earned a historical net return of 3-8%.
With the high possibility of borrowers defaulting or paying off loans early, lenders are encouraged to diversify across many borrowers to minimize risk. Like any money-making opportunity, the more risk you are willing to take, the higher the reward – but there are never any guarantees!
P2P is very high risk. So, take extra precaution.
Benefits and Risks for Borrowers
If you exhausted all the traditional sources to borrow money, P2P may be an option. The application process can be completed within minutes after which prospective borrowers can choose from a variety of loan options they qualify for. Even those with less-than-perfect credit may get approved, which makes P2P lending attractive for borrowers who have been rejected by other more-traditional loan providers. Also, some loans can be paid off early without penalty.
Before you take this route, the simplicity of borrowing money through P2P lending can be enticing to “overspend” or borrow more than necessary. This is where responsible borrowing comes in, which means borrowing only what you need and can repay within the specified terms. Delinquent loans are outsourced to a collection agency, which leads to big fees.
THE BOTTOM LINE:
The ease and convenience of P2P lending can be appealing, but there are significant risks to lending and borrowing money from individuals online. As such, no decision should be made without careful thought.
There may be times where it is necessary for us to become borrowers and P2P lending is simply another option to consider when shopping around for the best rates or when traditional lenders like banks reject your application for a loan.
For lenders looking to participate in a non-traditional way of investing, P2P is another platform to consider.
Whether you’re a borrower or lender, P2P lending should be taken with great precaution.
Disclaimer: This is NOT a promoted post. Capital Benchmark Partners, LLC (“CBP”) is not compensated for mentioning or recommending any third-party vendors or other organizations. If they are mentioned, it is strictly based off CBP’s independent research.
