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Peer to Peer Lending

A couple discusses peer to peer personal lending.

Peer to peer (P2P) lending combines two new types of banking that came about with the internet — “robo-advisors” that let you invest straight from a smartphone or laptop, and online banks where you can apply for loans with a simple click.

For borrowers, peer lending networks are a way to get lower interest plus better monthly payments on small business loans or personal loans to consolidate credit card debt or make a large purchase. A single bank might not want to lend to a risky borrower, but P2P platforms find many small investors to put together the full loan amount.

Because the risk is spread out, the pool of lenders can afford to charge lower interest rates — sometimes as low as 6 percent, but other times as high as 35 percent (depending on the borrower’s credit). Amounts borrowed range from $1,000 to $50,000 and usually have repayment times of between three and five years.

For young people entering the workforce with little credit history and a lot of debt, borrowing options can be limited. Traditional financial institutions have strict criteria to determine whether to give you a loan, and under what terms. P2P lenders look beyond just the length of one’s credit history to other factors such as education, current employment, work experience and consistent payment of other bills to judge creditworthiness.

Soft vs. Hard Credit Checks

There are many P2P lending platforms to choose from. Do a search for “peer to peer lending” and read reviews, customer experiences and complaints. Narrow your selection to your top three choices and go ahead and get a quote. (Read the fine print first.) To get the initial quote, you’ll have to provide some basic information, such as:

  • Name
  • Spouse’s name
  • Household income
  • Address
  • Birthdate

You’ll have to create an account and agree to the terms of service. Then they will do a “soft” credit inquiry, which means they can view your credit report, but it won’t count against your credit. No one except you and the P2P lender will be able to see that the inquiry into your credit was made.

However, once you accept the loan, then the lender will run a “hard” credit inquiry, which will add a mark to your credit report. From that point on, your repayment of the loan will be recorded on your credit. So, if you are late or miss your payments, it will count against you. But your positive repayment behavior shows up too. And, paying off a loan in a timely manner is a tremendous boost to your credit.

Investing in Peer Lending

Investors in P2P loans get their original investment back, plus a profit, if the borrower repays. If the borrower doesn’t repay, then the investors lose their investment. Returns can be very unpredictable. You could make 10 to 15 percent profit or you could average returns of 5 or 6 percent. And even with grading and rating systems, the P2P lending platform can no better predict who will default on a loan than a bank can. So, you can’t totally rely on “sure things.” Just because a borrower looks good on paper doesn’t necessarily mean they’ll repay.

If a loan you invested in defaults, the P2P lender might sell the loan to a third party who will try to collect on the loan. If any of the funds are recovered, the investors will get a portion of their money back, but lenders warn that this doesn’t happen often.

Choosing a Lender

Peer to peer loans can offer great terms to the right kind of borrower. If you’re one of those people with a short credit history or a low credit score, but you know you can afford to repay the loan on time, then P2P lenders could be for you. Always compare the terms on several borrowing options before taking on any big debt.

Other potential options include:

For each lending option, including the P2P lenders, compare:

  • Monthly payments
  • Length of loan
  • Interest you will pay
  • Penalties and fees
  • What happens if you default

It can take some time to calculate the real cost of each loan option, but it’s worth it to get a better deal. Sometimes a lower monthly payment is a worse deal because you end up paying way more in interest.

If you don’t repay a P2P loan, it will hurt your credit. Only agree to borrow what you can afford, then make consistent, on-time payments. This is the best way to build your credit for future loans, especially if you want to get a mortgage or large business loan later on.

Want more? Take SAM’s free Credit and Debt course.

[Any reference to a specific company, commercial product, process or service does not constitute or imply an endorsement or recommendation by the National Endowment for Financial Education.]

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