Blog Invest The advantages and disadvantages of peer to peer lending

The advantages and disadvantages of peer to peer lending

date August 25, 2020 time 5 min read 1870 views

Peer to peer platforms offer exceptional alternatives to traditional lenders, but that doesn’t mean peer-to-peer lending is flawless. We’re going to walk you through the advantages and disadvantages of peer to peer lending in business to help you decide if these loans are right for you.

Think bank loan rates are ridiculous? Tired of dinky interest on your savings account? You’re not the only one. That’s why there’s an entire industry created around solving both problems.

Peer-to-peer (P2P) lending is a business that involves directly advancing credit to organizations and individuals directly from lenders. Unlike with banks, there’s no official agent that acts as an intermediary in the deal. Potential borrowers and lenders meet each other organically on these online platforms. 

Pros and Cons of P2P lending in business
These are the pros and cons of P2P lending in business (source: pixabay.com)

The process usually looks like this:

  1.  Potential borrowers request loans on the P2P lending platform.
  2. The platform evaluates each of the borrowers’ eligibility for the loan and determines their credit rating.
  3. The lending platforms assigns each of the borrowers an interest rate.
  4. The platform approves qualified investors (lenders) and gives them the available loans and repayment options.
  5. The lender evaluates the provided options and chooses the most suitable one for them.

Even though many people consider peer-to-peer lending a great alternative source of financing and interest, you should take your time to learn the advantages and disadvantages of peer to peer lending before you decide to invest or take out loans.

Peer to peer lending has many advantages for borrowers and lenders
Peer to peer lending has many advantages for borrowers and lenders (source: pexels.com)

The advantages of P2P lending for borrowers

A fast and convenient application process

Since P2P lending platforms are online, the application process for a loan is both faster and more convenient than at a traditional lender. No need to spend time meeting with an underwriter. You just sign up, provide the necessary info, and you could have a loan in minutes.

Lower interest rates 

P2P platforms operate virtually, they have incredibly low overhead costs. Because they don’t need to gouge a profit out of you, you’re likely to have access to loans with low interest rates. Platforms also need to compete with traditional lenders so they will often give you better rates just to stay competitive. 

Less impact on your credit score

Many P2P platforms won’t conduct a hard credit check when you apply for a loan. If they had the same strict requirements as banks they wouldn’t be as useful to borrowers. Instead, they try to take in a range of factors including:

  • Age 
  • Income
  • Recent financial history
  • Employment status

More flexibility

Most peer-to-peer loans are unsecured. That means you can get them even if you do not have collateral. However, defaults are rarely tolerated and you could be slapped with an exorbitant interest rate next time you try to borrow again.

Many P2P lending platforms also allow you to settle your balance early with no extra fees. You can usually negotiate for better terms and get them as they want your business.

The disadvantages of P2P lending for borrowers

Personal scrutiny

While most platforms won’t perform a hard credit check, technology is improving. To ensure that you’re creditworthy, many platforms may still require a lot of personal information to determine your eligibility for loans. 

A disadvantage of peer to peer lending is that even though they often have different standards, if your credit score is poor, you may still not get access to these loans.

Application fees

P2P platforms may require you to pay a loan “origination fee”. This is how they make most of their money. Both the lender and the borrower must pay a cut of their interest/loan amount for the service. 

Lack of regulation

P2P lending is a fast-growing industry and regulators are still figuring out exactly how to classify their services. Make sure you thoroughly read through the security measures platforms take with your funds before borrowing.

The advantages of P2P lending for investors

An uncorrelated asset class

Many traditional investments like stocks, bonds, and even bank accounts derive their interest rates from the overall market. If the economy is good, then the interest is good. If the economy is bad then interest is also bad.

P2P loans are unique in that when times are bad, demand from borrowers actually goes up. While a bad economy may cause a slight uptick in defaults due to job losses, etc. a major advantage of peer to peer lending is that it can provide steady returns even in a down economy.

Steady returns

And speaking of steady returns, that’s another major advantage of P2P lending on the investor side. While stock and bond rates can fluctuate pretty drastically, P2P lending is usually an all-or-nothing game. Either the borrower pays off their loan or they don’t.

If you choose to invest in low-risk loans, you can usually expect to receive exactly the interest rate you signed up for. No surprises and no stop loss sells needed.

And the interest rates are usually pretty good too. On average playing a safe game will get you between 5-7% APR. Sites like Nerdwallet claim 6% is about all you can expect from stocks.

Diversification

A good investor knows the importance of diversification in a portfolio. And most peer to peer lending platforms give you quite a few options to choose from.

Every peer to peer investment is directly to an individual borrower, business, or group of borrowers. Each loan has its own rates, terms, and risk levels. Some platforms even offer pooled investment to multiple borrowers to mitigate risk across multiple investments.

P2P lending offers 3 main advantages over other investment types (source: p2pempire.com)

The disadvantages of P2P lending for investors

Risk of default

The biggest disadvantage of peer to peer lending is the risk of borrower default. While stock rates can fluctuate, high-risk P2P lending can quickly turn into an all-or-nothing game. Fortunately, there are many platforms today addressing the risk of default with new collateral options and lending pools.

Lack of transparency

As we mentioned before, many peer-to-peer platforms are new and still establishing a business model. Governments haven’t quite figured out how to regulate them properly.

Make sure you thoroughly assess the risk on any P2P lending platform you try. They should be able to tell you exactly where your money is going and where it is being held.

Poor customer service

Customer service may be the largest growing pain in fintech. 

Because most P2P platforms exist entirely online, they often skimp on customer service. Many of the top platforms today are difficult to contact if something happens to your loan or you are having trouble with part of the investing process.

Should P2P lending risk stop you from investing or borrowing?

Defaults are by far the biggest P2P lending risk
Defaults are by far the biggest P2P lending risk (source: financebuddha.com)

These are some of the major pros and cons of peer to peer lending. While there are risks in all investments. You can minimize potential P2P lending risks by working with a credible platform.

On our platform, MyConstant, we created our service to right the wrongs of the P2P industry. Our rates are transparent and we only charge a 1% origination fee to borrowers. We don’t need to perform invasive credit checks because all loans are at least 150% backed by collateral. 

You can earn anywhere from 4% to 7% on investments and all withdrawals are free. Most importantly, we have 24/7 customer service just a phone-call away any day of the week. That’s something we know you won’t find anywhere else. Sign up for a free account today and join the movement helping you do more with your money.

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