What Is Peer-to-Peer Lending?

And why a financial institution is probably a better idea

Peer-to-peer lending, P2PLend_Featuredalso known as social lending or crowd lending, is a type of debt financing that allows people to borrow and lend money without a financial institution getting involved. It began in the mid-2000s, and we’ve seen peer-to-peer lending platforms such as the Lending Club and Prosper, which pair up borrowers with investors, grow and become greatly successful over the years.

Some people lean toward peer-to-peer lending simply because it removes an intermediary from the process, but what these people might not know is this type of borrowing takes more time and involves more effort and risk than other lending options.

“It’s very risky. It’s like investing in the stock market. Everybody may have great intentions, but when you’re lending this money, you have to be prepared to lose it,” says Beverly Harzog, co-author of “The Complete Idiot’s Guide to Peer-to-Peer Lending.”

First, it’s important to note why people participate in peer-to-peer lending. Peer-to-peer lending can yield great benefits for lenders, as the loans generate income in the form of interest, which is typically much higher than traditional interest percentages from things like savings accounts or CDs. In addition, peer-to-peer lending allows people to take out a loan when they may not have otherwise been able to get approval from standard financial intermediaries.

However, peer-to-peer loans are not insured, so default can be especially painful for investors.

“You might get back a bit more than a bank, but it is more risky because people might default on loans,” says Christine Farnish, chairman of the Peer-to-Peer Finance Association. “Even with responsible credit ratings, you can still get things that go wrong. So you can’t assume you’ll get your capital back.”

In addition, the lender is not able to have full confidence in the borrower. Where a financial institution can reject lending due to a high likelihood of the borrower being unable to pay the money when due, peer-to-peer lending involves much more of a risk factor. This is typically why the interest rate for peer-to-peer loans may be higher than traditional prime loans.

Here are just some of the benefits of borrowing through a financial institution versus peer-to-peer lending:

Trust
Financial institutions go hand in hand with reliability. You know it’s a dependable and consistent place to get a loan simply because they’re regulated by state and federal agencies, and likely have ties to your community.

Loan limits
A financial institution is backed by the Small Business Administration, so it can provide larger amounts — a $5 million maximum on a 7(a) loan — than peer-to-peer lending allows for. Most peer-to-peer loans, depending on their venue and investors, usually have a maximum of around $35,000.

Interest rates
In 2012, small-business loan borrowers at the Lending Club paid an average rate of 13.4 percent, according to a research study by the Federal Reserve Board of Governors. However, according to the National Federation of Independent Businesses, borrowers who took out small-business loans from financial institutions paid an average of 6.3 percent. So an institution may save you money in the loan process.

Depending on your credit history and circumstances, you may benefit from using a financial institution for borrowing over peer-to-peer lending. To learn more, contact us today.

Used with Permission. Published by IMN Bank Adviser Includes copyrighted material of IMakeNews, Inc. and its suppliers.

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