Over the past decade, the number of consumers exploring peer-to-peer lending as an alternative to traditional bank loans has increased substantially. These personal loans can be used for a wide range of applications, from debt consolidation to home renovations to small business funding, and the terms of the loans are often comparable to personal loans obtained from a major bank. Many expect peer-to-peer lending to continue increasing in popularity in the near future as more people become comfortable with this funding method.
Peer-to-peer loans provide a way for individual investors to find personal loans to fund and a way for individuals that need personal loans to find investors that are willing to fund their loan. Borrowers can generally get their loan at a better interest rate than they would receive from a credit card company or other high interest loan while investors can get a better rate of return on their investment than they could with many traditional saving vehicles. In this way, peer-to-peer lending creates a win-win situation for responsible borrowers and risk-adverse investors.
There are a number of misconceptions about peer-to-peer lending that wide swaths of the population believe. One such misconception is that peer-to-peer lending is for consumers with bad credit that cannot obtain a loan using traditional methods. The truth is that consumers seeking peer-to-peer loans undergo a vigorous underwriting process, just like those that seek funding from banks, and the consumer’s credit score must be above a certain limit to qualify for a loan. People that have a recent history of defaulting on loans will not be able to get a peer-to-peer loan from any of the major peer-to-peer lending facilitators. This wasn’t the case a few years ago, but the industry has matured significantly since 2005/2006 when lending standards were looser.
Investors enjoy investing their money into peer-to-peer loans because the companies facilitating the loans have taken many steps to ensure the safety of the investor’s funds and reduce the risk of the investment. In addition to screening potential borrowers and assigning borrowers a grade according to their risk, many of these companies require automatic payments debited from the borrowers bank account on a monthly basis to repay the loan. The borrower must agree to this arrangement before any funds are disbursed to them. The investor also has the power to pick and choose which loans they want to fund based on the risk and the repayment terms displayed by the company.
Lastly, an important benefit that peer-to-peer loans offer is portfolio diversification. Peer-to-peer lending allows people the chance to invest in an alternative asset class which isn’t correlated with stock and bond performance. Following the general rule that you diversification is basically keeping your eggs in different baskets, it follows that investing in peer-to-peer loans in addition to stocks and bonds is more diverse than investing purely in stocks and bonds.