Pros and Cons of Peer-to-peer Lending
Peer-to-peer (P2P) lending has become an increasingly popular way for borrowers to obtain loans and investors to earn interest on their money in recent years. P2P lending connects borrowers directly with lenders, removing the need for a traditional financial institution intermediary.
While P2P lending provides some benefits over traditional lending models, there are also some drawbacks to consider. In this blog post, we will examine and share the key pros and cons of investing in and borrowing through P2P lending platforms.
1- Higher returns for investors: P2P loans typically offer lenders higher returns compared to other fixed-income investments such as bonds or savings accounts. The average P2P loan return is around 5-10%, higher than average bond yields.
2- Lower rates for borrowers: By removing financial intermediaries, P2P loans can offer lower interest rates for borrowers compared to traditional bank lending. P2P rates can be as low as 6-36% APR compared to credit card rates that can be 15-30%.
3- Access to credit: P2P platforms provide more access to affordable credit for borrowers who may not qualify for bank loans due to poor credit history or other factors. Investors have expanded access to a new asset class as well.
4- Speed: Receiving and funding P2P loans can happen more quickly than getting a loan through a bank, which requires extensive paperwork and underwriting. P2P loans can be funded in days.
1- Risks for lenders: There are no guarantees on P2P loans and borrower defaults remain a risk. Platform failure is also a risk if the P2P company goes out of business. Interest rates don’t fully compensate for these default risks.
2- Borrower vetting limitations: P2P platforms may not vet borrowers as rigorously as banks, which can expose lenders to higher default risks. Platforms rely heavily on credit scores and self-reported data.
3- Illiquidity: P2P loans are highly illiquid investments given their short duration. Lenders often have to wait until loans mature to regain access to capital. Early withdrawal usually involves trading loans at a discount on secondary markets with limited liquidity.
4- Regulatory uncertainty: The P2P lending industry still lacks a clear regulatory framework in many jurisdictions. Regulations are still evolving to protect lenders and borrowers appropriately.
P2P lending provides an innovative new platform for borrowing and lending money, providing some advantages over working directly with banks. However, the risks and limitations involved with these platforms are real. By understanding the pros and cons, investors and borrowers can determine if P2P lending fits their needs. Careful platform evaluation is needed, as regulations and industry practices continue to evolve. For many, P2P lending provides expanded access to capital in ways that can benefit both lenders and borrowers. Learn here more about p2p investing and passive income streams.
Q: What is peer-to-peer lending?
A: Peer-to-peer lending connects borrowers directly with lenders online, without the need for a traditional financial institution intermediary. Borrowers get loans funded by individual or institutional lenders looking to earn interest on their capital.
Q: How does P2P lending work?
A: Borrowers create loan listing profiles on P2P platforms. Investors browse listings and fund portions of loans that meet their criteria. The P2P platform facilitates loan servicing and payments. Borrowers repay lenders with interest.
Q: What are the rates and terms for P2P loans?
A: P2P rates vary across platforms but are often 6-36% APR, lower than credit cards but higher than secured loans. Loan terms also vary but are commonly 3-5 years for unsecured personal loans or 5-20 years for secured loans.
Q: Can I invest small amounts in P2P lending?
A: Yes, most P2P platforms allow you to invest as little as $25 in a loan, so you can invest incrementally in many loans to diversify your portfolio. Minimum investments vary by platform.
Q: Is P2P lending safe for lenders?
A: There are risks if borrowers default, but diversification helps minimize the impact. Look for platforms with stringent borrower vetting and “skin in the game” to align incentives. View it as higher-risk than bonds.
Q: How are P2P loans treated for tax purposes?
A: Interest earned on P2P loans is taxable income. You’ll get a 1099-INT form from platforms each year. Losses from defaults may be deductible. Consult a tax professional.
Q: Can I withdraw my investments early?
A: You can try to sell P2P loan fractions on secondary markets but liquidity is limited. Early withdrawal usually means accepting discounted pricing. Generally, treat P2P investments as tied up until maturity.