How Peer to Peer Loans Work

P2P Loans Offer an Alternative to Traditional Lenders

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Peer to peer (P2P) lending is a way to borrow without using a traditional bank or credit union. If you’re in need of a loan, you’ll definitely want to look at a few P2P lenders as you shop around. If you’ve got good credit, P2P loan rates can be surprisingly low. With less-than-perfect credit, you’ve still got a decent shot at getting approved for an affordable loan with these online lenders.

What is P2P Lending?

P2P loans are loans made by individuals and investors – as opposed to loans that come from your bank. People with extra money offer to lend that money to others (individuals and businesses) in need of cash. A P2P service (such as a website) matches lenders and borrowers so that the process is relatively easy for all involved.

Benefits of Borrowing with P2P

P2P loans aren’t always better than loans from a bank or credit union, but they have some unique features that make them competitive.

Low costs: you can often borrow at relatively low rates using P2P loans. You just need to pay enough interest to make your lender happy – and most of the interest you pay goes directly towards compensating your lender. With banks and credit unions, there are higher overhead costs for branch networks, other lines of business, and a large workforce. P2P borrowing is usually a better deal than using a credit card, but it always pays to compare rates.

To get your loan funded with a P2P lender, expect to pay an up-front origination fee of 1% to 5% of the amount of your loan. Compared to a personal loan at a bank, those fees can be high. On the other hand, they can come in lower when compared to a second mortgage (and the process is easier). Of course, there are additional charges for items like late payments.

Quick and easy: shopping for loans is a pain. And after you apply, you might have to wait a while to find out if you’re approved. With P2P loans, some of that pain is eased. The application process is generally easy, and you can often find out relatively quickly whether or not your loan is likely to get funded. Actual funding might take a few days or longer (as investors choose whether or not to put money towards your loan). Fortunately, if you need a quick decision, other non-bank online lenders can come through for you.

Credit matters, but blemishes are okay: in a world where lenders are reluctant to lend to anybody with negative items in their credit history, P2P lenders remain an attractive option. You need to have decent credit to get approved – a FICO score in the mid 600’s is best – but P2P might give you more options than you have available from lenders where you live. The worse your credit is, the more these loans will cost (with higher interest rates), but that’s the case anywhere you go.

Types of Loans

P2P loans started out as personal unsecured loans – you could borrow for any legal purpose you wanted, and you did not have to pledge collateral to get approved for the loan. Those are still the most common types of loans, and they are the most flexible: you can put the money towards debt consolidation, a new car, home improvements, or starting a business. If you want to borrow for higher education, verify whether or not that is possible with your lender.

Over time, specialized P2P lenders have started to offer loans for specific uses (like business loans) and loans that are secured by collateral.

Popular P2P Lenders

The list of P2P lenders is constantly growing. The concept got popular with and Lending Club, both of which are still major players in the P2P space. If you’re going to get a loan, it’s probably worth getting a quote from one of those two sources. Whatever you do, research each lender and read reviews from reputable sources before you apply for a loan – you’ll need to provide sensitive information such as your Social Security Number, and you don't want to give that information to an identity thief (or a plain-old money thief).

There are plenty of other lenders, and some good options come from less “pure” P2P lenders: instead of borrowing from individual lenders, you borrow from other non-bank lenders. These online loans are funded by different types of investors, and the money might even come from banks (without the traditional bank borrowing experience).

How it Works

To borrow with a P2P loan, choose a lender and start the application process. You’ll need to provide details about yourself, and you might need to explain how you intend to use the money. Your lender will check your credit, and if you’re eligible for the service your loan will be listed for lenders to fund.

You’ll need to wait for funding, which can take several days or a few weeks. If your loan is funded, you’ll receive the money electronically and you’ll repay the loan with automatic electronic payments. You’ll generally repay over a period of three to five years, but you can almost always prepay without any penalty – which helps you save money on interest.

Credit reporting: as you repay your loan, you’ll build credit (most lenders report your activity to credit bureaus), which should help you borrow on better terms in the future. Of course, if payments come late or you default on the loan, your credit will suffer – so make it a priority and communicate with your lender if you fall on hard times.

Is it Safe to Borrow with P2P?

Of course, it depends on what you mean by safe, but most lenders are relatively consumer-friendly. They keep your information as secure as any other financial institution, and all communication is done through an encrypted browser session. Your identity should be kept secret from lenders, and interest rates are generally competitive with what you can find elsewhere (you’ll almost certainly pay less than you’d pay for a payday loan).