Peer-to-peer lending is an excellent form of finance for those with bad credit. While the exact terms of your loan will depend on your lender, this form of finance can result in lower interest rates, better savings, and increased flexibility. Though these advantages make peer-to-peer lending a great alternative, it isn’t without its downsides.
In this article, we will be discussing the advantages and disadvantages of peer-to-peer lending, and help you make the right decision for your situation.
What is peer-to-peer lending?
Peer-to-peer lending, often abbreviated as P2P lending, is a form of private lending completely separate from banks. The process is without an intermediary, involving private individuals and organisations lending directly to other private individuals or organisations. As such, it is an incredibly flexible form of finance, depending solely on what the two parties are prepared to agree. Peer-to-peer lending is usually facilitated by online platforms, allowing both borrowers and lenders to meet and discuss their options.
The peer-to-peer lending process generally follows the same format. First, a prospective borrower will make their request on a peer-to-peer lending platform. The platform will then assess the borrower’s credit rating and determine eligibility for the requested loan. Depending on the results of this assessment, borrowers will then be given an interest rate.
In addition to borrowers, a peer-to-peer platform also hosts qualified lenders. These lenders will be presented with the available loans, allowing them to choose the best option for their situation. The lender and borrower will then discuss the finer details, and either agree or disagree to work together.
If traditional forms of lending are unavailable or unappealing to you, peer-to-peer lending could be the perfect alternative. However, before taking the plunge, you should first consider the advantages and disadvantages.
Advantages of peer to peer lending
As we’ve touched on, peer-to-peer lending has a wide range of benefits, both for borrowers and lenders. For borrowers, consider these advantages:
- Fast access to capital – Speed is often one of the most important qualities in a loan. With peer-to-peer lending, the application process is streamlined, something that can act as a bottleneck for other loans. All you need to do is sign up, answer a few important questions, and finalise the process with a lender. You could see the money in your account within the same day.
- Less emphasis on your credit rating – With peer-to-peer lending, your credit rating isn’t the be-all and end-all. This is quite unlike most traditional forms of finance you’d get from a bank, where a poor credit rating usually spells the end of your application. While your credit rating is still factored in, other factors such as age, employment, and income are preferred.
- Better interest rates than alternatives – Operating online doesn’t only increase the speed of P2P lending; it reduces operating costs too. This lower operating cost means less of a need to use you for profit, leading to better interest rates. This can save you money on interest payments, which would be higher than other traditional forms of finance.
Peer-to-peer lending also has significant advantages for lenders, too. These include:
- An opportunity to diversify – Diversification is the golden rule for investment. Focusing too much on any given investment can pose quite the risk to your profits, after all. Peer-to-peer lending gives investors a great opportunity to do just that, placing a great degree of control in your hands.
- A separate form of investment – Similar to the previous advantage, peer-to-peer lending offers investors a fairly independent means of diversifying their portfolios. Unlike most other investments that suffer during an economic downturn, peer-to-peer lending benefits from increased demand. As such, it is an investment that can provide returns even in a slump.
- A reliable source of income – Provided you invest in a low-risk loan, you are all but guaranteed a stable return. Where other forms of passive income can fluctuate due to a wide range of factors, peer-to-peer lending is pretty fixed. You’ll either earn back your investment with a little extra on top, or leave empty-handed. To avoid the latter scenario, be sure to invest carefully, opting for low-risk loans and doing your research.
Disadvantages of peer to peer lending
While peer-to-peer lending has its advantages, it isn’t without its issues.
For borrowers, these include:
- Can be invasive – Depending on the platform, you may be required to provide a lot of personal information during your application. Some are less extensive in their questioning than others, but as a general rule, a fair bit will be asked of you to determine your eligibility.
- Poorly regulated – Peer-to-peer lending is a fairly new but rapidly expanding industry. As such, it has outpaced the lawmakers’ ability to properly regulate, or even classify, this form of finance. Because of this, it can be riskier than alternatives. You should carefully read over the platform’s policies and security measures before entering into any agreements.
- Fees – As with any service, peer-to-peer platforms make their money from fees. The main fee is a “loan origination fee”, which must be paid by both the borrower and the lender.
For lenders, the disadvantages are:
- Potentially low transparency – Peer-to-peer lending is poorly regulated. As such, there is a chance that you sign up to an unscrupulous platform that isn’t forthcoming with where your money is going. To mitigate this risk, you should take care to research any platform you intend to entrust your money to.
- Customer service leaves a lot to be desired – For reasons similar to the above, peer-to-peer lending doesn’t have the best track record with customer service. If you have problems or questions, it can be a hassle to contact customer service, with little else you can do.
- Can be risky – The biggest disadvantage to peer-to-peer lending is the risk. There is always the possibility that your borrower defaults, leaving you with a lighter wallet and nothing to show for it. This problem is somewhat addressed by the new collateral options implemented by some platforms, but it isn’t ironclad protection. As always, you should monitor risk carefully and do your research before finalising any agreements.
Conclusion
As with anything, peer-to-peer lending has its advantages and disadvantages. For some, the flexibility will be just what they need to raise capital for a new venture. For others, the risk will simply be too great to justify. To make the right choice, it is vital that you carefully assess your situation, and weigh the pros and cons of this novel form of lending. By doing so, you give yourself the best chance of success.