Ravi Chandran
Peer-to-peer (P2P) lending – also known as social lending or crowdlending – is a method of debt financing that enables individuals to borrow and lend money without the use of an official financial institution as an intermediary.
By: Hitesh Khan/
Peer-to-peer lending removes the middleman from the process, but it also involves more time, effort and risk than the general brick-and-mortar lending scenarios.
With crowdlending, borrowers take loans from individual investors who are willing to lend their own money for an agreed interest rate. The profile of a borrower is usually displayed on a peer-to-peer online platform where investors can assess these profiles to determine whether they would want to risk lending money to a borrower.
A borrower might receive the full loan amount or only a portion of what he asked for from an investor. In the case of the latter, the remaining portion of the loan may be funded by one or more investors in the peer lending marketplace.
In crowdlending, a loan may have multiple sources and monthly repayment has to be made to each of the individual sources.
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Crowdlending platforms connect borrowers to investors with attractive interest rates. For lenders, the loans generate income in the form of interest which can often exceed the interest amount that can be earned through savings vehicles, such as savings accounts and CDs. In addition, an investor is able to earn a higher return on his investment than he can get from the stock market through the interest payments he receives monthly from the borrower.
On the other hand, P2P loans give borrowers access to financing that they may not have gotten approval for from standard financial intermediaries. Furthermore, a borrower gets a more favorable interest rate on her loan than one she would otherwise have gotten from a bank.
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In both the crowdlending lending model and the family and friend lending model, the key is the formalising of the loan agreement.
In peer to peer lending among family members, the loan agreement between family members can be as simple as a promissory note. A promissory note is simply a written promise to repay a loan or debt. The promissory note includes the names and the under specific terms – usually at a stated time, through a specified series of payments, or upon demand.
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Since peer-to-peer lending companies offering these services generally operate online, they can run with lower overhead and provide the service more cheaply than traditional financial institutions.
As a result, lenders can earn higher returns compared to savings and investment products offered by banks, while borrowers can borrow money at lower interest rates, even after the P2P lending company has taken a fee for providing the match-making platform and credit checking the borrower.
Also known as crowdlending, many peer-to-peer loans are unsecured personal loans, though some of the largest amounts are lent to businesses. Secured loans are sometimes offered by using luxury assets such as jewelry, watches, vintage cars, fine art, buildings, aircraft and other business assets as collateral. They are made to an individual, company or charity.
The interest rates can be set by lenders who compete for the lowest rate on the reverse auction model or fixed by the intermediary company on the basis of an analysis of the borrower’s credit. The lender’s investment in the loan is not normally protected by any government guarantee. On some services, lenders mitigate the risk of bad debt by choosing which borrowers to lend to, and mitigate total risk by diversifying their investments among different borrowers.
One of the main advantages of crowdlending for borrowers can sometimes be better rates than traditional bank rates can offer. The advantages for lenders can be higher returns than obtainable from a savings account or other investments, but subject to risk of loss, unlike a savings account. Interest rates and the methodology for calculating those rates varies among peer-to-peer lending platforms. The interest rates may also have a lower volatility than other investment types.
Since peer-to-peer lending companies offering these services generally operate online, they can run with lower overhead and provide the service more cheaply than traditional financial institutions. As a result, lenders can earn higher returns compared to savings and investment products offered by banks, while borrowers can borrow money at lower interest rates, even after the P2P lending company has taken a fee for providing the match-making platform and credit checking the borrower.
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