What is peer-to-peer lending?

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Sometimes called person-to-person or social lending, peer-to-peer, or P2P, lending refers to a loan between individual consumers. As such peer-to-peer loans have been around since the invention of money.

In its truest form, peer-to-peer lending does not involve traditional financial institutions, such as banks, credit unions or finance companies. However, modern peer-to-peer lending is not limited to an individual borrower or personal loans. Some P2P financing may be provided to businesses, such as a startup raising money for expansion. Such cases are sometimes more appropriately called peer-to-peer investing.

Online peer-to-peer lending and investing

Traditional peer-to-peer loans still exist today, from a son borrowing money from his mother to one friend lending money to another. However, the internet has expanded and facilitated the availability of P2P loans and social lending to people who may not know each other.

Individuals and even entrepreneurs who need money can use P2P websites to try to find individuals who may be willing to invest in them and provide online loans. Similarly, individuals looking for alternative investing opportunities may consider P2P sites to find potential borrowers.

These sites also offer crowd-funding opportunities, which allow individual investors and lenders to more easily pool resources – and share the risk. A lender may only be willing to finance a portion of a prospective borrower’s requested amount. But if other individual lenders join in providing the remaining portion, the borrower can still get the loan amount he or she requested.

In addition to connecting potential borrowers with potential lenders, many peer-to-peer lending sites also help individuals with credit reports, loan documents and servicing (collecting payments).

Why use P2P loans?

There are many reasons why individuals may turn to peer-to-peer lending sites to borrow or lend money. Often, a prospective borrower may require a personal loan that banks, credit unions and traditional lenders will not provide.

Prospective lenders also have varying reasons for participating in P2P loans. In the case of relatives and friends lending to each other, it’s because the lender personally knows the borrower. For individual investors and lenders participating on P2P sites, it may be to find investment alternatives that pay more than CDs and other investments.

This brings up an important point about P2P loans. Just as with traditional loans from banks, credit unions and finance companies, P2P loans entail risks – especially for the lender.

In many cases, P2P lenders are actually taking a much higher risk than traditional lenders who have more experience with consumer loans. And if the borrower defaults, P2P lenders will have to absorb the loss or pursue collections.

As mentioned above, some P2P websites do provide lenders with credit reports on prospective borrowers. By providing prospective lenders with credit reports, those individual lenders will have a better understanding of the risk they’re taking.

Because of the risk involved, many borrowers may not always find the loan amount or terms they would like.

Peer-to-peer lending’s stamina in the consumer finance arena has yet to be established as a viable, long-term industry. For consumers unable to find adequate financing elsewhere, it is one option to consider. However, prospective borrowers and lenders should always remember to conduct their due diligence and talk with a financial advisor before agreeing to any peer-to-peer loan.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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