Have you ever used eBay? Do you know what a relief it is to sell and buy directly to the other party instead of dealing with various intermediaries and the confusion it brings along? If you have experienced it, then you can appreciate the blessing of P2P lending.
P2P lending is short for peer-to-peer lending, where you can borrow or lend money to another individual without having to deal with the intermediaries such as credit unions and banks. It also termed as social lending.
P2P lending is equally popular among the lenders and the borrowers since it curtails interest rates for the borrowers along with increasing the returns for the individuals responsible for supplying the capital. On the downside, this method of lending requires greater amount of time and effort. Moreover, the risk involved in P2P lending is also greater than in other forms of lending.
We have discussed this modern form of lending in detail below:
P2P— the Social Lending
P2P lending is the result of various technological as well as social trends. Some of these are as follows:
- Freeformers Individuals who support the idea of social activism and personal freedom when it comes to working are called freeformers. Instead of working for a single company for several years, they believe in working on several projects by collaborating in networks. They do not favor the large corporations such as banks and prefer to work alone rather than reporting to an authority. P2P lending, therefore, is a great option for them.
- Technological disintermediation Various technological changes along with several international changes and globalization trend have reduced the use of the middleman in many industries.
- Mass Collaboration The advanced usage of the internet has made it easier for groups to interact. They can work together online without wasting time and energy in going to a particular place to get some work done. Social networking sites and eBay are a classic example of how internet has removed the need of intermediaries.
- Microlending Finally, microlending has played a major role in introducing the concept of lending smaller amount of loans to individuals who cannot afford to pay a lot in bulk.
How does P2P lending works?
P2P lending works in a rather simple manner. First of all, anyone who is interested in being a part of P2P lending signs up and joins the P2P lending website. This website belongs to a company that makes its profits through a minor fee charged by both parties involved. It serves them by making the transaction easy and keeping a record of fund transfers.
Not everyone can borrow money using the P2P option. Before a person is eligible to borrow money, the P2P lender makes a thorough check on their financial status including personal, credits, and employment checks. Since P2P lending involves greater risk, the rules are also extremely strict. For example, people with bad credit cannot avail this option.
Once the lender is satisfied, the person becomes eligible to borrow money. Now they can opt for one of the following two options:
- In first scenario, the lender will give the borrower four or five categories. These are risk categories and you are allowed to borrow on the current rate for your risk category for that specific day.
- In the second case, the borrower’s loan will be auctioned to people who have funds they want to lend. Only the lender or the bidder has access to information they have provided such as their financial status, their specific need for which they are asking for the money, and their personal information. Either their loan is then bid with them providing an interest rate, or if the entire loan is funded, the lenders bid according to the interest rate they offer.
P2P lenders can make use of the P2P Company in two ways. Besides going for bid on loans at a good interest rate, they can have their funds spread between different borrowers. The lenders have the freedom to choose any risk category. If they choose a higher risk category, their return will also be greater. However, in this case, the risk factor will also be greater, and so will be the chances of default.
Advantages and Disadvantages of P2P Lending
P2P lending offers the following benefits:
- Both lenders and borrowers enjoy cost advantages if they use a P2P company instead of using a bank. For example, the lenders will have a higher percentage of returns while the borrowers will spend less.
- Most people are interested in knowing about the other party. P2P lending offers this option. Once a lender knows whom they are lending to and why the other person needs the money, they feel more satisfied. Similarly, it is easier for them to trust the other party if they know the reason of borrowing as well.
- Another great advantage of P2P lending is that it opens up chances of charity. For example if a borrower has a bad credit history but their reason for asking for the money is genuine, the lender might ask for lesser return and thus offer lower interest rate.
- There are many people who feel nervous about using a bank for any set of personal reasons. P2P lending is a great option for such individuals.
The disadvantages of the using P2P lending options are given below:
- It is not easy to have your borrowing application accepted at a P2P company if you have a bad credit history since their rules are rather stringent.
- If the P2P loans are funded through the auction process, getting a loan often becomes quite a lengthy process. In some cases, it is easier to just walk to a bank and get a loan.
- A P2P lender may be made to lend money because the other person has a good story but it might be nothing more than a story and the lender will be left manipulated. This risk is absent in case of going for a bank.
While there are disadvantages of P2P lending, the benefits are numerous too. If you are looking for a P2P lending option, try to compare various P2P companies offering the services.