What is peer-to-peer lending?
Updated 2:10 p.m. UTC Nov. 9, 2023
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Key points
- Peer-to-peer loans are a type of personal loan funded by individuals instead of financial institutions.
- P2P lending platforms connect potential borrowers with investors and pre-vet them.
- These loans can be easier to qualify for than traditional personal loans.
- On the other hand, they also tend to come with higher interest rates because they present more risk to the lender.
If you need a personal loan, you probably know that banks are one place to get them. But a less traditional source of financing that you may not have considered is peer-to-peer (P2P) lending.
Peer-to-peer loans give consumers the ability to borrow money from other people — in theory, their peers — instead of asking a financial institution for money.
Let’s take a closer look at peer-to-peer loans and how they work.
How does P2P lending work?
Peer-to-peer loans are available through online platforms. Investors who are interested in providing loans are matched with potential borrowers. Investors and borrowers never actually interact with each other. Instead, the platform handles everything, including the application and vetting process, setting rates and fees and collecting payments.
Some companies that provide P2P loans include Prosper, LendingClub, Upstart, Funding Circle and Peerform.
Example of a peer-to-peer loan
Say you want to borrow a personal loan, but you haven’t been able to find one from a traditional lender that meets your needs. Perhaps your credit isn’t strong enough, or you need the cash quickly.
So you decide to borrow from a peer-to-peer lender instead. First, you would choose a lending platform and create an account. After sharing some personal details and answering questions about how you plan to use the loan, you’ll receive a borrower rating. This will determine whether you qualify for a loan, and if so, at what terms.
Lenders on the platform then have the opportunity to review your information and offer to fund your loan. If you are matched with a lender (or lenders who pool funds together), you then submit a full application and receive your money within a few days — assuming there is no more information or documentation needed.
Pros and cons of peer-to-peer loans
One of the biggest benefits of peer-to-peer loans is that they are often easier to qualify for. “The requirements for P2P loans tend to be less stringent than traditional loans,” says Markia Brown, a certified financial education instructor at Money Plug. The process also tends to be quicker since it’s done online, making it easy to compare offers and secure financing in a short period of time.
P2P platforms also allow you to shop around for quotes through soft credit inquiries, so your credit won’t be impacted as you compare. It’s only when you formally accept an offer that the platform performs a hard inquiry on your credit, which may temporarily ding your score by a few points.
“The downside to P2P loans is that the interest rates are sometimes higher, since the lender assumes most of the risk,” Brown said. That means your monthly payments could be higher than with a traditional personal loan, and you may pay more in interest charges over the life of the loan.
| PROS | CONS |
|---|---|
Typically easier to qualify for than other loan products
| Interest rates can be higher than other loans
|
Faster application, funding process
| Fees could make borrowing more expensive
|
Prequalification is common, so you can shop around without harming your credit
|
P2P vs. personal loans: What are the differences?
At a high level, P2P loans and personal loans are essentially the same thing. They let you borrow money to use for a wide variety of reasons. Payments are made in monthly installments, typically over the course of a few years. The interest rates are also usually fixed.
One of the main differences between traditional personal loans and peer-to-peer loans is how they’re funded. Personal loans come from financial institutions, such as banks, credit unions and online lenders. P2P loans, on the other hand, are provided by individual investors via a lending platform.
Another difference is that while P2P loans are typically unsecured, meaning no collateral is required to get a loan, some traditional personal loans are secured. This means that the borrower needs to put up collateral — such as a bank account, vehicle, real estate or some other asset — in order to secure the loan. Secured loans tend to have lower interest rates, but the lender can seize the asset if you don’t repay the debt.
Frequently asked questions (FAQs)
When the borrower makes payments on their loan, a portion goes toward paying back the principal and the rest goes toward interest charges. Individuals who fund peer-to-peer loans make money by earning interest on their investment. The interest rate depends on several factors, including the riskiness of the loan and the cut that the lending platform takes.
As a borrower, a P2P loan usually won’t impact your taxes at all. In some cases, you may be able to deduct peer-to-peer personal loan interest on your taxes, such as when the loan is used to pay for business expenses, qualified education expenses or certain taxable investments. As a lender, you’ll need to claim any earnings from a P2P loan as income.
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