Borrowing With Peer-to-Peer Loans: How It Works

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Peer-to-peer (P2P) lending avoids using a traditional bank or credit union. If you’re in the market for a loan, it’s worth evaluating P2P lenders as you shop around. P2P loan rates can be surprisingly low, especially if your credit score is good, and the application process may be easier than what you’d experience when borrowing from a traditional bank. Even with less-than-perfect credit, you can potentially get approved for an affordable loan with these online lenders.

What Is P2P Borrowing?

P2P loans are loans that individuals and investors make—as distinguished from loans that you obtain from your bank. People with available money offer to lend it to individuals and businesses through online services. A P2P service (typically a website or mobile app) is a central marketplace matching lenders and borrowers, making the process relatively easy and efficient for everyone involved.

Benefits of Borrowing With P2P

P2P loans aren’t always better than loans from traditional banks and credit unions, but they are typically competitive.

Low rates: You can often borrow at relatively low rates using P2P loans. Banks and credit unions must cover overhead costs for branch networks, other lines of business, and a large workforce. P2P borrowing is more streamlined and typically digital-native, leveraging better new technology. Thus, the cost structure is more optimized than that of traditional lenders. P2P borrowing is usually a better deal than using a credit card, but it’s always prudent to compare rates. As you do so, pay attention to promotional rates, and determine how quickly you’ll pay off your debt.

Origination fees: You may need to pay an up-front origination fee of 1% to 8% to fund your loan with a P2P lender. That charge depends on the total amount you borrow, so a $1,000 loan might incur a $50 fee, for example. Compared with the cost of a personal loan at a bank, these fees can be high. On the other hand, you’d probably pay an even bigger origination fee for a second mortgage, and the personal loan process tends to be easier to navigate. Of course, you'd pay additional fees for issues such as late payments.

Quick and easy: Shopping for loans through traditional channels is a hassle, and after you apply, you may need to endure a lengthy wait during the approval process. Taking out P2P loans can ease some of that pain. The application process is typically straightforward, and you can often find out relatively quickly whether or not your loan is approved. Actual funding might take roughly a week (as investors choose whether or not to put money toward your loan). Decisions are increasingly quick, as non-bank lenders online fund loans as large investors.

Credit matters, but blemishes are okay: In a world where lenders are reluctant to lend to anyone with negative marks on their credit history, P2P lenders remain an attractive option. You may need decent credit to get approved—a FICO score in the mid 600s or higher is best—but P2P might offer you more options than are currently available in your area. As an example, Upstart requires a minimum FICO or Vantage score of 620 to qualify for a loan, although individuals without significant credit history may also qualify. The worse your credit situation is, the more these loans will cost you (in the form of higher interest rates), but that’s the case with most lenders.

Types of Loans

P2P loans started out as personal unsecured loans—you could borrow for any legal purpose, and you did not have to pledge collateral to get approved for a loan.

Personal loans are still the most common P2P loans, and they are also the most flexible. (Use our calculator below to figure out what size loan makes sense for you.) You can use use the money toward debt consolidation, a new car, home improvements, or starting a business. If you want to borrow for higher education, verify whether or not your lender permits borrowing for that specific purpose. Student loans might be a better option for educational funding anyway.

Specialized P2P lenders now offer loans for specific uses (like small business loans or fertility treatment) as well as loans that you can secure with collateral.

Popular P2P Lenders

The list of P2P choices is continually growing. P2P loans became popular with Prosper and LendingClub, both of which still offer fixed-rate loan options. If you’re going the P2P loan route, it’s probably worth getting a quote from one of those two sources (in addition to checking quotes from others, if you’d like). Be sure to research any lender on your radar, and read reviews from reputable sources before applying for a loan. To borrow, you are required to provide sensitive information like your Social Security number, and you don't want to give that information to an identity thief.

Several other good options are available. Some may not be “pure” P2P lenders—these lenders aren't individuals, but they aren't traditional bank lenders either. A variety of investors fund these online loans, and the money might even originate from banks (without the traditional bank-borrowing experience).

How It Works

To borrow money through a P2P loan, select a lender and begin the application process. You typically need to provide details about yourself, and the lender may inquire about your plans for the money. Most loans are personal loans, but some lenders may promote specialized packages to best serve you (like loan packages for home improvements or debt consolidation, for example). The lender checks your credit, and if you’re eligible for the service, investors can fund the loan.

With some P2P lenders, you may need to wait a while for funding. The process can take several days or a few weeks. If your loan is funded, you receive the money electronically and repay the loan through automatic bank drafts. 

You typically repay over three to five years, but you can almost always prepay without any penalty, which helps you save money on interest.

Credit reporting: Prompt repayment on your loan builds your credit. Most lenders report your activity to credit bureaus, which should help you borrow on better terms in the future. However, if you are prone to late payments or default on the loan, your credit will suffer. It’s crucial to make payments a priority and to communicate with your lender if you fall on hard times.

Is It Safe to Borrow With P2P?

The answer to this question depends on what you mean by "safe," but most mainstream lenders are relatively consumer-friendly.

Data: Established P2P lenders should guard your information as securely as any other financial institution would, and all communication should take place through an encrypted browser session or app. Thus, consider the data security criterion when you pick your P2P lender.

Privacy: Your identity should be kept hidden from individual lenders, but review privacy policies carefully to understand what information investors will receive. 

Rates: Interest rates are typically competitive with those you can find elsewhere. You’ll almost certainly pay less with P2P lending than you would with a payday loan.

If you get a loan with a variable rate, be aware that interest rates can rise. If they do, your payment will increase.