Peer-to-peer lending involves lending money to people unrelated to the lender. Depending on the arrangement, these are usually unsecured personal loans ranging from smaller to larger amounts. Peer-to-peer lending, or P2PL, bypasses traditional financing routes such as banks and other institutions. It differs from peer-to-peer investing (P2PI), primarily concerned with lenders.
Peer-to-peer lending may be arranged through companies specializing in setting up such connections between peers and is often done online. Peer-to-peer lending is often conducted for individual purposes, although it can sometimes be an aspect of small business loans (especially smaller “mom and pop” type businesses).
Peer-to-peer fundraising promotes supporters of a charity or non-profit organization to raise funds individually. Rather than having one main crowdfunding page where everyone donates, people can create multiple individual fundraising pages with peer-to-peer fundraising, which they will share with their networks.
Many peer-to-peer loans are unsecured personal loans, though some of the largest amounts are lent to businesses. Sometimes, secured loans are offered by using luxury assets as collateral, such as jewelry, watches, vintage cars, fine art, buildings, aircraft, and other business assets. These loans can be given to individuals, companies, and charities. Peer-to-peer lending also includes student loans, commercial and real estate loans, payday loans, secured business loans, leasing, and factoring.
Interest rates can be set by lenders who fight for the lowest rate on a reverse auction model or by an intermediary company based on the borrower’s credit analysis. Government guarantees do not normally protect the lender’s investment in the loan. Depending on the service, lenders may mitigate their risk of bad debt by choosing which borrowers to lend to and by diversifying their investments among different borrowers.
A lending intermediary generates revenue by collecting a one-time fee on funded loans from borrowers and by charging either investors or borrowers (either a fixed amount annually or a percentage of the loan amount) a loan servicing fee. In comparison to stock markets, peer-to-peer lending tends to be less volatile and less liquid.
Peer-to-peer lending in the U.S. began in February 2006 with the launch of Prosper Marketplace and LendingClub. Prosper and LendingClub are both based in San Francisco, California.
Peer-to-peer platforms had few restrictions on borrower eligibility in the early days, which caused adverse selection problems and high default rates. Furthermore, some investors viewed the lack of liquidity for these loans, most of which have a minimum three-year term, as undesirable.
In 2008, the U.S. Securities and Exchange Commission (SEC) required peer-to-peer companies to register their offerings as securities under the Securities Act of 1933. The registration process was arduous for Prosper and LendingClub, while others exited the U.S. market altogether. LendingClub and Prosper were approved by the SEC to offer investors notes backed by payments from loans.
Prosper amended its filing to allow banks to sell loans they have previously funded on the Prosper platform. In partnership with FOLIOfn, LendingClub and Prosper created a secondary market for their notes to provide liquidity to investors. Prosper had a mandatory registration at this time, whereas LendingClub had a voluntary registration.
As a result, as opposed to traditional securitization markets, the loan requests of peer-to-peer companies were more transparent for lenders and secondary buyers, who could access detailed information about each loan before deciding which loans to fund. In addition, peer-to-peer companies must regularly update their prospectuses to describe their services. The SEC makes the reports available online via EDGAR (Electronic Data-Gathering, Analysis, and Retrieval).
As a result of the financial crisis of 2007-2008, more people turned to peer-to-peer companies for borrowing. As borrowers defaulted more frequently, investors were less willing to take on unnecessary risk in the peer-to-peer market.
What Are Some Characteristics of Peer-to-Peer Lending Arrangements?
Peer-to-peer lending is associated with certain characteristics since it is not connected with traditional loan processes. These include:
- The loans are not secured and are not insured by the government
- P2P companies usually act as intermediaries between lenders and borrowers
- Transactions are generally conducted online
- Lenders and borrowers usually have no prior relationship
Peer-to-peer lending has several advantages. The lenders, for instance, have a greater choice of borrowers to work with. There may also be more flexibility in creating and revising loan contracts themselves.
Early peer-to-peer lending was also marked by disintermediation and reliance on social networks, but these features have faded. Although it is still true that the advent of the internet and e-commerce has made it possible to do away with traditional financial intermediaries and that people are less likely to default to the members of their social circles, new intermediaries have proved to be time and cost-saving. Crowdsourcing can open up new opportunities for lenders and borrowers unfamiliar with each other.
Most peer-to-peer intermediaries provide the following services:
- Investment platform that enables borrowers to attract lenders and investors to identify and purchase loans that fit their investment criteria
- Credit models for loan approvals and pricing
- Verifying the borrower’s identity, bank account, employment, and income
- Checking borrower credit and removing unqualified borrowers
- Receiving payments from borrowers and forwarding them to lenders who invested in the loan
- Servicing loans, providing customer service to borrowers, and trying to collect payments from delinquent borrowers
- Compliance with legal requirements and reporting
- Marketing (finding new lenders and borrowers)
What Are Some Common Peer-to-Peer Lending Disputes?
Peer-to-peer lending can sometimes cause legal disputes. This is a common dispute when the lender fails to repay the loan amounts according to the terms. Many participants in P2PL arrangements come from a poor credit background, which is a particular concern. Many people seek P2PL loans because they do not qualify for a bank or other institution. This puts the lender at risk.
Another dispute is where either the lender or the borrower engages in loan fraud. This can happen, for instance, if the intermediary peer-to-peer lending company does not conduct thorough background checks of all participants. To resolve P2PL disputes, a lawsuit is often required.
Is Peer-to-Peer Lending (P2P) Safe?
Compared to savings accounts and certificates of deposit, peer-to-peer lending is riskier but offers higher interest rates. The reason is that investors in peer-to-peer lending sites assume most of the risk, which banks and other financial institutions usually assume.
What Is the Market Size for Peer-to-Peer Lending?
According to Precedence Research, the global peer-to-peer lending market was worth $83,79 billion in 2021. This figure is expected to reach $705.81 billion by 2031.
Is Peer-to-Peer Lending Right for You?
To invest in peer-to-peer lending, create an account on a P2P lending site and begin lending money to borrowers. These sites typically let the lender choose the profile of their borrowers so that they can choose between high risk/high returns or more modest returns. You can also invest in P2P lending sites by buying their stock since many are public companies.
Do I Need a Lawyer for Help with a Peer-To-Peer Lending Issue?
Peer-to-peer lending can have its advantages as well as its risks. You may wish to hire a credit lawyer in your area if you need help with a peer-to-peer lending arrangement. Working with an attorney can ensure that your interests and assets are protected. Your lawyer can also represent you in a court of law if you need to file a lawsuit due to a dispute.