Peer-to-Peer (P2P) Loans

Person-to-person or peer-to-peer (P2P) loans don’t come from traditional lenders like banks and credit unions. Instead, you're borrowing money from another person, or multiple people, generally through a website that sets up the transaction and processes your payments. You'll still pay interest on your loan—and perhaps a little more than you would on a private loan from a bank—but you may have an easier time getting approved for one of these loans over a traditional bank loan. 

The Role of P2P Companies

P2P loans have changed the world of lending. In the broadest sense, a P2P loan can happen between any two people, including loans from friends and family. That said, P2P lending usually refers to an online service that handles all of the logistics for both borrowers and lenders.

In addition to providing agreements, payment processing, and borrower evaluation, P2P lending service providers make it easier for people to connect. Instead of borrowing only from people you know or those in your community, you can access a P2P lender's website and find people who loan money nationwide.

Numerous websites have made P2P loans widely available. Prosper was one of the pioneers of P2P, but there are plenty of other P2P lenders, including LendingClub.

Reasons to Get a P2P Loan

P2P loans can help borrowers overcome two of their biggest challenges: cost and approval.

Lower costs: P2P loans often have higher interest rates than loans available from traditional lenders, including some online banks. However, they offer lower costs than payday lenders, carrying large balances on credit cards, or other less desirable options when you're low on cash and don't have a good credit score. The most popular lenders offer fixed interest rates so that you have a predictable, level monthly payment.

Origination fees for P2P loans can range as high as 8%, depending at least in part on your credit rating. The fee is deducted from your loan proceeds, so keep that in mind when deciding how much to borrow.

Easier approval: Some lenders want to work only with people who have good credit and the best debt-to-income ratios. But P2P lenders are often more willing to work with borrowers who’ve had problems in the past or who are in the process of building credit for the first time in their lives. A few P2P lenders, such as NetCredit, specialize in working with people with low credit scores.

How P2P Lending Works

Each P2P lender is slightly different, but the general idea is that there are lots of people out there wanting to earn more on their money than they can get from a savings account. P2P sites serve as marketplaces to connect these lenders with borrowers who need cash quickly. Prosper's business model was an “eBay for loans.”

Qualifying: To borrow, you generally need decent, but not perfect, credit. Again, different services have different requirements, and lenders can also set limits on how much risk they’re willing to take. At most big P2P lenders, several risk categories are available for investors to choose from. If you have high credit scores and income, you’ll fall into the lower-risk categories. Some lenders look at “alternative” information such as your education and work history, which can be handy if you have a limited credit history.

Applying: With most lenders, you just fill out an application that’s similar to any other loan application. In some cases, you’ll provide a personal narrative or otherwise tell lenders about yourself and your plans for the money. You might even be able to use social networks to help you get approved. Once your application is accepted, funding might be more or less instant, or it could take a few days for investors to decide to fund your loan. If you are rejected, you should receive an explanation why.

Costs: Your interest costs are generally included in your monthly payment. In addition to the origination fee, additional fees may be charged for things like late payments, returned checks, and electronic payments that can't be processed due to insufficient funds.

Repayment: If your loan is approved, you’ll generally repay over a period of three to five years, and you can usually prepay without any penalty. Payments usually come out of your checking account automatically unless you arrange for a different process.

Credit reporting: The most popular online P2P lenders report your activity to credit bureaus. As a result, your on-time payments will help you build and improve your credit, making it easier to borrow on better terms in the future. However, if payments fail to go through or you default on the loan, your credit will suffer. Make those payments a priority and communicate with your lender if you are in danger of missing one.

When you're first shopping for a loan, your credit report will include a soft inquiry that has only a small effect on your credit score. A lender who decides to offer you a loan will do a more complete credit check that is called a hard inquiry. 

Lenders: The original P2P lenders funded loans entirely from other individuals. But the P2P space is evolving, and financial institutions are increasingly funding loans, whether directly or indirectly, instead of individuals. If that matters to you—you might not care, as long as you’re getting a loan from somebody—research the service you’re thinking of using and find out where the funding comes from.