What is Peer-to-Peer (P2P) Lending?

Written by Bryan Daly
Fact-checked by Caitlin Wood

Updated March 15, 2021

What is Peer-to-Peer (P2P) Lending?

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Loans P2p Lending Peer-to-peer

Whether you’re looking to fund your business or pay for your personal expenses, there are sure to be plenty of physical lenders and online lending platforms in your area to apply with. The only problem is that, in certain situations, it can be tough to get approved for a large loan with a good interest rate and favourable conditions. This is why peer-to-peer lending platforms have gain popularity in recent years.  

Check out this p2p lending platform on Reddit. 

What is P2P Lending?

Peer-to-peer lending (sometimes referred to as “person-to-person” or “social” lending) is when you borrow credit, such as a loan, from anonymous lenders and investors via an online platform. Unlike with traditional lending, where you borrow from and repay a single company, multiple lenders and investors may pool their resources, each offering to finance a percentage of your loan in exchange for a cut of the eventual profit.

So, instead of applying with your bank or credit union, where approval standards are more difficult to pass, a P2P platform can match you up with several lenders or investors in your area, any of which might be better suited to your financial needs. 

P2P Lending For Businesses 

For instance, peer-to-peer lending is now a popular solution for businesses that need capital to finance part of their operation, like startup costs. Although you can find a lot of traditional business lenders on a P2P platform, institutional investors also offer business loans on these websites, so that they can add variety to their stock & trade portfolios. 

P2P Lending For Individuals 

Individuals can get financing through a P2P platform as well. So, if you’re looking for some extra cash to cover your personal expenses, such as home repairs or high-interest debt, a peer-to-peer loan might be a good option to consider. People you know can also use P2P lending to invest in your business and earn interest on the side.    

P2P Lending Overall

All this to say that peer-to-peer lending is becoming more and more sought after these days, especially by people and businesses who are having trouble qualifying with their financial institution for one reason or another. In fact, many financial companies now specialize in peer-to-peer lending and can offer you all kinds of financing.

Types of Loans You Can Get Through Peer-to-Peer Lending

Although every P2P lender has its own products, financing amounts and regulations, most of these platforms offer:

• Personal Loans – A specific amount of borrowed money that you repay in installments (with interest) over a set schedule. Usually, the loan gets deposited directly to your personal bank account and your debt will be broken down into several months or years of monthly, weekly, bi-weekly, or bi-monthly payments.

• Business Loans – Can be larger and feature longer terms than most personal loans. Tighter restrictions may also apply. While a P2P loan can be easier to get than a bank loan, you may need a strong business plan, solid projected revenue and high business credit score to qualify for decent rates and conditions. 

• Debt Consolidation Loans – This type of loan is meant specifically to help you or your business pay off multiple debts in one shot. The overall goal is to leave you with a single repayment plan, which would hopefully save you money in interest, despite rates being slightly higher than some regular loans. 

Keep in mind that these are just a few of the more common loan types you’ll find on a P2P platform. Your own peer-to-peer lender might offer different options and rates, this is why it’s important to compare multiple platforms before you make your final decision.

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The Advantages and Disadvantages of Peer-to-Peer Lending

Now that you have a better understanding of how peer-to-peer lending works, it’s time to learn about the advantages and disadvantages of P2P loans. Carefully consider these pros and cons, as they can significantly affect your finances:

Advantages For Borrowers

• Individuals and businesses can get the money they need to finance their expenses while repaying their debt over several months or years. Unlike some bills, which require immediate payment, this can be more affordable. 

• Approval requirements aren’t as tough as those of a traditional prime lender. You can also get your money faster, as well as qualify for better rates and conditions, especially if you or your business have strong finances and credit.

• More often than not, P2P loans are unsecured, meaning no collateral is required to get approved. So, unlike with a secured loan, where your assets could be seized if you miss too many payments, this isn’t a danger with P2P borrowing. 

• Interest rates can be lower than other personal or business financing products, like credit cards. Plus, you won’t be charged any prepayment penalties to pay back your loan ahead of schedule. Both these benefits can help you save money.

Disadvantages For Borrowers

• While interest rates can be lower than some credit products, they may be higher than other loans, particularly if your credit isn’t great. What’s worse, having a personal or business credit score under 630 can get you denied altogether.

• Additionally, some P2P lending platforms charge more fees than traditional lenders. You may even be subject to a 6% loan origination fee which, when coupled with a high-interest rate (sometimes over 30% APR) can cost a lot.

• Depending on what platform you use and which lenders or investors you get paired up with, you may not be able to borrow more than $30,000 – $40,000 at any given time (lower amounts than some traditional will lenders offer).

Advantages For Lenders/Investors

• Funding an individual or business can frequently lead to higher profits than with other types of investments and savings programs. Despite the risk involved, lending out larger amounts of credit can yield even better financial results.

• As mentioned, investors can benefit from P2P lending because it automatically diversifies their portfolios. While plenty of stocks and bonds are available, some platforms also offer mutual funds, real estate financing and other alternatives.

• Once you start collecting payments from your borrowers, you can withdraw the proceeds from your P2P platform account and spend them how you wish. If you prefer, you can reinvest them into other peer-to-peer lending programs. 

Disadvantages For Lenders/Investors

• P2P investments are not protected by the Canadian government. So, if borrowers default on their loans, you could lose money. Selling higher quality loans is less risky but can lead to less interest in return (and vice versa). 

• If you don’t accept more risk by offering a variety of loans, your portfolio may not be diverse enough to make any real profit on your investments. Experts say having at least 100 – 200 active loans in your portfolio will yield the best results.

• Since loan terms can be several years long, you may see a slower return on your investments than you would with regular stocks and bonds. Not to mention, P2P lending is a relatively new industry, so it can be a much harder market to predict. 

The Cost of Peer-to-Peer Lending

When applying for any credit product, one of the most important things to think about is how much it will cost you while you’re still paying it off. Although a peer-to-peer loan functions almost the same as a normal loan, the final cost can vary depending on a number of factors, including but not limited to:

• Loan Amount & Term Length – While larger, higher-quality loans usually result in lower interest rates, they can lead to longer repayment terms. The lengthier your term is, the more interest you’ll pay overall, which is why it can be helpful to take advantage of the “no prepayment penalties” rule when it’s an option. 

• Interest Rate – Remember, P2P loans (especially those with shorter terms) can come with higher interest rates than other credit products. The worse your credit, income and debts are when you apply, the riskier your lender/investor will consider you and the higher your rate will be (the same goes for your business). 

• Fees – Also mentioned earlier, peer-to-peer lending can be accompanied by hefty fees, mainly because there’s a lot of administrative work involved with the financing, investment, and closing processes. Plus, you could be charged a penalty fee for every late, incomplete or missed payment on your profile.

How Do You Qualify For a Peer-to-Peer Loan?

Luckily, applying for peer-to-peer lending isn’t too different from a regular personal or business loan. The stronger your finances are, the easier it will be to qualify for a large loan with a decent interest rate and an affordable term. Here are some of the main elements your lenders or investors might inspect when you apply:

• Income – Of course, the primary thing that P2P loan providers want to know is that you’ll be able to afford all the costs associated with your payments. The higher your income is prior to applying, the better your loan conditions and interest rate will be. 

• Credit Score – Your credit tells the loan provider how you’ve handled any previous or existing debts. If you have a good credit score (650 – 900), they will be more inclined to approve you for favourable loan conditions. Your business has multiple scores with all of Canada’s credit bureaus but similar rules apply.

• Debts – It will also be easier to qualify for a decent P2P loan if you or your business have little-to-no outstanding debts, thereby minimizing risk for the lender. The same goes for debts you’ve had in recent years. If you have a responsible payment history, your lender will consider you even less risky.

• Business Plan – If you’re applying for a P2P business loan, your lender/investor may ask you to present a plan that outlines how profitable your business will be in the future. Your plan should feature all the most relevant details, such as your company’s projected revenue, current income, and unpaid debt levels. 

Is a Peer-to-Peer Loan Right For Me?

Unless you’re an experienced borrower or investor, it can be tough to know whether peer-to-peer lending is actually the best solution for you. After all, there can be some serious risk and cost associated with the repayment process, not to mention a low rate of return if you’re lending to someone with a long loan term. 

All that said, there are plenty of benefits that you can access by getting a peer-to-peer loan or funding someone else’s, namely the ability to get approved for a large amount of financing with good conditions and fewer requirements than a bank or credit union.

Before you apply for a peer-to-peer loan, get a price quote from your lending platform, so you can factor the costs into your budget. Whether you’re a borrower or an investor, it’s equally essential to think about what could happen in the future. If the costs and risks associated with peer-to-peer lending seem too daunting, it might be safer to speak with a financial advisor and find an alternative.