What is p2p lending and how does it work?

The purpose of this article is to explain to you what this new financial service is in the easiest to understand way possible.

The crisis of 2008 made banks much more conservative about lending to companies and individuals, which created the conditions for the creation of numerous p2p lending platforms that offer an alternative way to invest and secure financing for companies and individuals.

This revolutionary service, part of the rapidly growing sharing economy, enables ordinary people to earn high returns by lending to other people who are given the opportunity to borrow on terms acceptable to them.

What is the difference between p2p lending and bank loans?

To better explain how p2p lending platforms work, we will make a comparison with traditional banking. In this type of financing, the potential borrower visits a bank or non-bank financial institution and applies for financing. Unlike traditional financing in p2p platforms, borrowers can apply online and receive the money on an account or through a partner institution, but unlike banks in p2p platforms, the amount for the loan comes from another person - an investor for whom the yield from the loan is also.

What is p2p lending?

P2P lending is part of the fast-growing economic model of the sharing economy. This type of lending allows people to act as a bank and lend to other people through online platforms. The principle of operation is as follows: the potential borrower applies for a loan, the platform evaluates his creditworthiness and gives him a rating, after which he lists the loan request along with information about the borrower on the platform and allows investors registered on the platform to finance the loan. The platform is an intermediary between investors and borrowers and takes care of protecting the rights of both parties. Apart from directly from investors in the platforms, loans can also be financed by non-bank financial institutions, called originators, which are then sold to investors in p2p platforms of this type. As in the second case, platforms serve only as an intermediary between investors and originators.

 

The main reasons why people take p2p loans

1. One of the reasons why users use p2p loans is that compared to bank loans, where the loan applicant has to provide multiple documents and wait for approval for several days, p2p lending is an easier and faster way to get a loan. and in some cases it can be a cheaper option, compared to bank loans.
2. Another reason for using p2p loans is the possibility of combining multiple obligations to different institutions, whereby the user covers all obligations with a loan from a p2p platform, which results in a reduction of the interest rate and the total amount of monthly payments.
3. The third reason is that most platforms offer a fixed interest rate for the entire term of the loan, while not all bank loans have a fixed interest rate, and a floating interest rate can lead to an increase in loan payments in the event of an unfavorable economic situation.

The flexibility with which p2p platforms work makes them an increasingly preferred partner of users and their popularity has grown significantly in the last few years.

 

What are the requirements for borrowers?

Most p2p lending platforms rate potential borrowers based on their credit history, income, occupation, debt-to-income ratio and other factors. This rating helps investors decide which loans to finance based on the yield they are looking for.

The interest rate for borrowers also depends on the rating, the better their rating, the lower the interest rate on the loan. As the rating increases, so does the probability that the loan will be financed by investors.

However, the lack of an excellent rating does not automatically mean that the loan will not be financed, but rather that if the borrower is approved for a loan he will have to pay a higher interest rate, which is quite tempting for more aggressive investors.

 

Advantages of investing in p2p loans

Borrowers are not the only ones who benefit from the development of p2p lending platforms, investors also benefit from them, who can profit well from their savings by investing them in this type of platform. Here are some of the benefits:

1. Saving money in bank deposits protects the funds of the depositors, but ultimately brings them losses, since the annual interest on deposits is between 0-1% and the annual inflation is 3.5%, i.e. the net loss of investment in a bank deposit is not less than 2.5% per year.

Unlike the current interest rates on bank deposits in the p2p lending platforms investors can earn between 6-12.2% annual return on invested funds depending on the risk they are willing to take. Investors who play it safe and invest in low-risk loans can earn around 5-6% per year, and those who are willing to invest in riskier loans can earn 18-20%.

Assessing the level of risk is easy, as we mentioned earlier in the article, since most platforms rate their borrowers, with those with a lower rating being riskier and those with a higher rating being better investments. low risk.

2. Investments in consumer loans are a stable and profitable investment, but until recently they were only possible for banks and non-bank financial institutions that granted them. Nowadays, p2p platforms allow their investors to act as a bank and grant loans, thus earning a good return.

Investing in p2p loans is one of the most stable forms of investment, as it allows investors to diversify their investments among many different borrowers and platforms and thus greatly reduce the risk of default by borrowers.

3. It is not to be underestimated that compared to other investment opportunities, p2p lending investment is relatively easier to understand and manage. Many platforms offer the option of automated investing, which means that users can choose a strategy and amount to be reinvested and the platform does it for them.

The development of technology and the adoption of the sharing economy, of which p2p lending is a part, have a significant positive impact on our society because they have the potential to reduce the costs of borrowers and increase the income of investors, enabling a more equitable and efficient distribution of financial resources. resources.