The lending business which is becoming increasingly popular is Peer to Peer lending business. Many investors are looking forward to getting more out of their money; Peer to Peer lending is one of the best options for them. The low-interest rates tempt the borrowers to opt for this type of loan. It is also the reason why this lending business has grown fast over time.
If you are looking at Peer to Peer lending business as an investment option, you must understand the advantages and the risks associated with this kind of investment for your money.
This article explains the working process of this lending business, along with the pros and cons of it.
What is Peer-to-Peer lending?
It is also known as direct lending, P2P Lending has been in use for more than ten years now. Although it is a decade old lending business; however, it has been recently considered as a mainstream lending method.
In this lending type, the banks and financial institutes are side-lined, and a direct link is established between borrowers and investors.
Generally, borrowers and investors are linked via online platforms. This lending process involves online transactions, thus allowing the investor and the borrower to transact using the exclusive online platform.
The operating costs are lower, thus offering higher returns on the investment. In addition to that, the borrowers have the option of evaluating multiple lenders and decide the best option.
Investors can also get back more money as they do not have any obligation of giving a certain percentage to financial organizations.
Just like typical bank loans, for obtaining P2P loans, a standard credit score of 600 needs to be maintained. There are also options for borrowers with lower scores for availing this loan.
Unlike banks, one of the benefits of P2P is you do not have to pay any application fee or bear any additional charges. Generally, P2P cuts an origination fee from the total loan amount; the standard deduction rates range between 1 to 5%.
For instance, if you have taken a loan of $10,000, and the origination fee is 2%, in that case, $200 will be the origination fee.
How does Peer to Peer work?
P2P follows a simple and straightforward method. As stated earlier, the investors and the borrowers use a unique lending platform for any transaction concerning P2P. The following points tell us the general working method of P2P lending business:
- First, a borrower logs on to a P2P online platform. He accesses an online application and fills it up for getting a loan.
- Next, the application is thoroughly assessed, considering the credit score and risk associated with it. The next step involves assigning a proper interest rate.
- After that, the platform approves the application, and the available loan options are shared with the borrower. The platform determines the loan amount, depending on the credit score and interest rates already assigned.
- The applicant checks out the different options and selects the best option.
- After selection, the borrower must make the payment towards interest and also arrange for repayment of the sum assured during the time of maturity.
Pros of P2P lending
- Availability of higher returns: P2P gives you higher returns compared to the standard returns offered by financial institutions.
- Diversification of Risks: P2P enables you to scatter the capital amount across various loans. Therefore, spreading the capital helps you to control the risk exposure in a better way.
- Selection: You have the liberty to select whom you want to lend your money. As an instance, you can decide whether you’d like to give your money to people who have secured assets like a property or business.
- User-friendly platforms: Since the transactions are exclusively online, hence it is easy to use.
- Personal Savings: P2P enables you to earn interest, and the same is added to your savings allowance.
- Early liquidation of the money: With P2P, you can access your money before the ending of the loan as long as there is an opportunity to sell the loan position. However, this varies from one lending platform to others; hence, you need to make sure about this as soon as you start transacting on a lending platform.
Cons of P2P Lending
- Choose the platform carefully: Unlike the banks, the Financial Services Compensation does not cover your fund. Hence, you might find yourself at higher risks if you do not choose your platform diligently.
- Disallowance of tax-free interest: Except for the Personal Savings Allowance, your earned interest gets taxed. Also, while applying the annual tax return, you need to declare the tax amount.
- Slower lending of money: You are not going to earn any interest for the time that your fund takes to be lent out. In P2P, the lending process is not as fast as it is with other finances.
- Time Consuming: As there is a wide array of choices, it consumes a lot of time when it comes to portfolio management.
Popular P2P Sites
Some of the well-known P2P sites include Prosper, Lending Club, Peerform, Upstart, FundingCircle, StreetShares, and Kiva.
Prosper originated in 2005, and it is the first P2P lending business. It is an immensely popular lending business with a massive number of people involved.
Just like Prosper, Lending Circle became significantly famous just after its launch in 2007. The borrowers can opt for business loans, personal loans, and auto refinancing options.
Future of Lending
Although the P2P lending business is demanding, experts say that it is still at an elementary stage, and will soon pick up over the coming years.
Considering the growing demand for P2P, we can undoubtedly say that there is a great potential in the market for lending business. The online business still has a long way to go, and to that extent where it will be possible to utilize its full potential.
Now that you are aware of the advantages and disadvantages of P2P, it will be easier to decide whether it is the right option for you!
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