Over the years, peer to peer lending has evolved into a multibillion industry globally, with its leverage lying in the proprietary credit evaluation algorithm that is not limited to credit scores. Pioneered in the UK, peer to peer (P2P) lending facilitates loans to individual consumers and small businesses through an operator’s online platform. The money used for P2P lending is sourced from investors who make a pool of investments in the issuing platform in exchange for interests. As a result, P2P lending has become a potential area of interest for investors who are looking for higher yields beyond the conventional securities markets. This article outlines everything that you should know about peer to peer investments.
Peer to Peer Lending Explained
P2P lending is where a borrowing party is matched with an investor who is willing to issue loans to individuals or businesses directly. The transaction is executed through online platforms, eliminating intermediaries, such as banks and money lending institutions. P2P investment is a mutual venture. This means that borrowers get the financial funding they need, while investors gain interests with favourable rates.
How Peer to Peer Lending Works
According to statistics by Statista, the P2P lending industry is expected to grow into a $1 Trillion sector by 2050. Following the continued growth in peer to peer lending, investors have found this to be an attractive area of investment. But how exactly does P2P investment work? This step by step guide explains the process that constitutes peer to peer lending.
Step 1: Completion of an Online Application
The entire P2P process takes place in a designated P2P platform. The borrower fills out an online application form on their platform of choice. Applicants may be required to indicate details, such as reasons for the application and why they think obtaining a loan is a good idea.
Step 2: Application Review
Once the application is submitted, the platform assesses it to establish the credit rating and risks of the applicant. The platform may also assign the borrower a grade or rating which influences the offers the applicants receive. If satisfied by offers made after the review, the borrower may proceed or terminate the application process.
Step 3: Application Approval
After the platform is through with approval of the application, investors are matched with the borrower through a loan request. In most cases, P2P loans are crowdfunded. This means that the loan request may be received and processed by more than one investor. These investors will evaluate the information and rating attached to an application to decide on the approval. After approving the loan request, the interested investors will make offers to the borrower based on their rating.
Step 4: Accepting the Offers
Investors might present the borrower with several loan options and conditions. If the applicant is interested in continuing with the application, they will review and accept the terms and conditions of the most suitable offer. Depending on the P2P platform, the borrower will have the money deposited in their account within the same day or a week later.
Step 5: Payments
Once the applicant has received the loan, they will be required to make periodic interest payments as per the loan agreement. Once the loan matures, the borrower will also be required to pay the principal amount. Like any other lender, P2P investors report the borrowing accounts to the national credit bureau agencies. Late payment of periodic interests or principle amount will, therefore, hurt your credit score.
Types of Peer to Peer Loans
With the growth in the number of P2P lending companies, the types of P2P loans have also evolved into a more diverse scope. Here are some of the P2P loan types that individuals and businesses can borrow today.
Loans to Individuals
P2P lenders provide a wide range of loans to individual borrowers, including the following;
This is likely the most common loan type offered by P2P lending companies. Borrowers find P2P platforms more appealing for personal loans, following the platforms’ flexibility, convenience, and minimal restrictions. Most P2P companies are also popular for issuing loans to borrowers with narrow and fair credit scores, a foundational basis upon which banks would reject an applicant. Notably, borrowers can get up to $35,000, if not more, of personal loans. You also cannot go without noticing the debt consolidation capacity of the P2P lending companies. This means that borrowers struggling with large debts can merge various credit lines into one fixed-rate loan.
Typically, auto loans are secured against the purchased car. But that is not the case with the P2P auto loans. Borrowing auto loans with a P2P lending company is not necessarily. This means that one can borrow money to refinance a car without having the loan declared as an official car loan. While the interest rates attached to auto loans may be higher with P2P lending companies than the conventional banks, borrowers are at the benefit of receiving the loans without the car acting as the collateral.
P2P lending platforms are probably more popular with student loans than any other type of loan. While it is extremely difficult to find lenders giving student loans, individuals can rely on P2P lending companies for this loan type. In fact, some P2P platforms, such as CommonBond and SoFi specialise in student loan refinancing. For investors, refinancing student loans via P2P platforms is an added advantage. This is because individuals borrowing student loans must be income and credit-qualified to access the loans.
With most traditional health insurance policies disallowing the insuring of certain medical conditions, medical loans have become quite popular. Fortunately, P2P lending companies have become a reliable source of medical loans, issuing up to $50,000 for a period of 2 to 7 years. Most people borrow medical loans to finance surgeries, cosmetic treatment, fertility treatments, and other urgent health care services.
Although P2P lending companies are not as competitive as other lenders in issuing mortgages, borrowers can rely on the platforms for a mortgage loan. Most P2P lending platforms featuring mortgages have been known to offer loans valuing up to $3 million. Financing is available for town homes, condos, planned unit developments, and single-family homes.
Loans to Businesses
Small businesses can also borrow loans from P2P lending companies to finance various business operations. The various types of loans issued to businesses include the following;
Most banks and money lending institutions issuing business loans have stringent criteria and requirements put in place in processing these loans. For example, businesses are required to fill out multiple forms, provide massive amounts of documentation, not forgetting the high-interest rates that come with business loans. Fortunately, with P2P lending platforms, businesses can acquire loans through a simple application process with low-interest rates. Businesses struggling with their credit rating do not have to worry as P2P business loans are credit-flexible.
A business mortgage is designed for businesses or companies that are remortgaging or buying a property that will be used for commercial purposes. This type of loan is also available on P2P lending platforms at a lower interest and mandatory down payment as compared with banks and conventional lenders. The good thing with business mortgages offered by P2P lenders is that they are free from origination fees, and borrowers can have the loan closed after 1 month of application.
The Best Peer to Peer Lenders
While P2P lending started in 2005 in the UK, the competition across the world has grown significantly. Here is a highlight of some of the best platforms for P2P investment.
Best P2P Platforms in the United States
When it comes to the P2P lending community, LendingClub is a global giant. Based in San Francisco, California, LendingClub has attracted over 3 million borrowers. The company has issued loans worth over $50 billion, making LendingClub one of the dominating P2P lenders globally. Applicants can borrow up to $40000 of personal loans. For investors, any amount from $600 can get you started.
Peerform is another global P2P lending giant that was founded in 2010. Borrowers are eligible for loans worth up to $25000. Interest rates vary from 5.99% to 29.99%, depending on the borrower’s credit rating.
Upstart was started by former Google experts in 2012, having an issuance history of loans worth over $6.7 billion. Applicants can borrow loans of up to $50000 at an interest rate of 6.18%. To invest in Upstart, you must have an annual income of $200000 or $1 million net worth.
Best P2P Platforms in the UK
Zopa is one of the best and the longest operating P2P lending companies in the UK, having started in 2005. By 2017, Zopa had issued loans valued over £2 billion. Zopa has three loan offerings to borrowers, which are issued at interest rates of 3.5%, 4.5%, and 6.5% per annum.
Ratesetter is another leading giant in the P2P lending business. Ratesetter has issued over £2 billion worth of loans. Ratesetter investors are estimated to receive an average rate of 4.8% on loans issued, with zero fees charged to them. Ratesetter is an excellent option for risk-averse investors and those interested in fully automated investments.
Funding Circle was founded in 2017, with thousands of actively borrowing businesses. The platform hosts over 46000 lenders, who are estimated to receive an average return of 7% on their investment. There is also no minimum amount to investing in this platform. Funding Circle issues loans at an interest rate of 1%.
Benefits of Investing in P2P Lending
Over the last few years, the rate of peer to peer investments has grown spontaneously, in light of the zero-charges investment environment. Here is an outline of some of the benefits of investing in P2P lending.
Control Over Your Portfolio
Unlike the other investment avenues, the P2P lending platforms give you full control over your investments. You can filter notes based on factors, such as debt to income ratio, credit score range, loan term, and loan types. As a result, an investor can influence the variables that surround their portfolio of investments.
Compared to other investments, investing in P2P lending presents investors with higher returns. Getting a portfolio of investments with varying credit grades can even see you generate greater returns.
Capacity to Invest in Notes
One notable advantage of investing in P2P lending is that you do not have to service an entire loan by yourself. A big loan can be divided into multiple notes, as one note can be valued for as low as $25. As a result, investors can diversify an investment with the lowest amounts possible.
Tips on How to Best Invest in P2P Lending
To be successful in P2P investments, investors must be well versed with the mitigation of potential risks as they maximise on their returns. This section covers basic tips on how investors can leverage their P2P investments.
Consider Diversifying Your Investment
As earlier stated, in P2P lending, you do not have to invest in one single loan. The platforms allow multiple investors to fund one loan in the form of notes. To minimise on the risk of investment inP2P lending, consider investing in hundreds of these notes. This enables you to lower the risk of generating losses in any one of your investments portfolio.
Limit your P2P Investment
In economic downturns, there is a relatively high potential of borrower defaults. This is why it is essential that you limit your investment to a considerable small proportion of your total investment portfolio. This way, you will expose your entire portfolio to the risk of such borrower defaults.
You Might Want to Reinvest Loan Payments
P2P loans are designed to self-amortise after specified periodic times. This means that you will receive repayments on a regular basis (usually monthly) in the form of interests. You must, therefore, be diligent on how you handle these repayments. Consider reinvesting the repayments you receive by purchasing new notes. This is to ensure that your returns do not decline when the loans are fully paid.
Investing in Peer to Peer lending is an ideal way for investors to earn high returns at competitive rates without costly intermediaries. Investors inject their money into a P2P platform, where borrowers get the money at an interest. Such platforms include LendingClub, Peerform, Upstart, Zopa, and Funding Circle. The P2P industry is growing spontaneously, with its value predicted to hit the $1 trillion mark by 2050.