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Until a few years ago, the only option for those who needed a personal loan was with the bank. However, the chance of approval for traditional personal loans is relatively lower, and the terms could be poor.
Peer-to-peer lending is not as nascent as the NFT market. However, the first modern peer-to-peer lending marketplace came in 2005 with the launching of Zopa, a UK-based lending platform.
Since then, consumers have been able to borrow money without going to the bank, often with less bureaucracy and favorable terms than traditional personal loans offer. This article shows how peer-to-peer lending marketplace drive the digital lending industry forward.
What is a marketplace or peer-to-peer lending?
Peer-to-peer lending, also called white-label P2P lending, is a type of financial process that lets private individuals borrow and lend money (business or personal loans) directly to each other.
To break it down further, peer-to-peer means something like “person-to-person” or “private person to private person.”
A peer-to-peer loan is called crowd lending or a P2P loan. First, the loan is processed between two private individuals. Then a peer-to-peer lending marketplace is, in simple terms, a peer-to-peer lending platform. Finally, an intermediary combines the lender, borrower, methods, and lending rules.
These lending marketplaces help connect borrowers and investors while setting a minimum credit score and loan terms.
They provide details about the loan amount and purpose, such as debt consolidation, business loans, home improvement, etc.
Another common term used is C2C credit – consumer-to-consumer credit. This type of lending is still new in the finance market and has only been established on the financial market for less than 20 years.
With a peer-to-peer loan, there is no intermediary bank or traditional financial institution. Instead, a marketplace acts as an active platform where investors and borrowers can meet. This results in significant advantages for both sides:
The bureaucratic effort and high bank fees are eliminated. Investors can set up a diversified portfolio and thus always keep an eye on risk control if they want to invest money safely. In addition, the marketplace’s innovative investment tools help to assess borrowers better. As a result, investors benefit from higher returns than other asset classes.
The three best peer-to-peer lending marketplaces
- Funding Circle
On Funding Circle, you can put a minimum investment amount of £1,000. But, again, this is a significant sum of money, so as we mentioned with Zopa, we urge you never to invest funds you can’t afford to lose.
Investing in this lending platform can earn between 4.5% and 6.5% yearly. They have two loan options:
- Conservative (low-risk business loans for lower yield)
- Balanced (variable risk business loans for a higher projected return).
The Funding Circle only offers business loans, and each business they approve for loans is placed in a “risk bucket.” The risk range, combined with how long they need the peer-to-peer loan, determines how much interest rates you can get.
As we mentioned with Zopa, on Funding Circle, you can spread your funding across several loans to minimize the amount you’d lose if a company can’t keep up with repayments.
You can either withdraw repayments as they come in or reinvest them directly into other loans to earn more interest.
And, if you decide to sell your investment to other lenders, a transfer payment of 1.25% will be taken from the total amount of the sale.
Funding Circle only lends to businesses, and they currently offer loans of up to £250,000 through the government’s Business Interruption Loan Scheme (CBILS).
That said, different peer-to-peer lending platforms offer various loans at different rates, so there may be others besides Ratesetter, Zopa, and Funding Circle that are best for you.
- Zopa
Once again, Zopa is the oldest P2P lending site offering personal loans. These are the two main types of products they provide to investors:
- Zopa Core (3.4% – 5%)
- Zopa Plus (4% – 6%).
For these products, you must invest a minimum of £1,000. It’s a significant investment, so don’t lend the money if you can’t afford it. Please also consider low-risk ways to earn interest, such as putting the money in a savings account.
Each borrower has a different rate and will make their monthly repayments on other days.
And, as repayments are made, you can automatically reinvest the money to earn more interest. But, if you choose to keep the monthly repayments, they will stay in your account, and you can withdraw them at any time for free.
If you decide to take your money back before borrowers’ repayments are due, you can sell the rest of the loaned money to other investors for a 1% fee.
It’s also worth checking out Zopa’s Innovative Finance ISA, which gives you tax-free interest, but you must remember that the FSCS does not cover it.
Zopa offers personal and car loans from £1,000 to £25,000 over one to five years. Rates vary, but their website gives loan examples of 8.7% – 17% APR (remember, APR is the interest rate plus origination fees).
An example on their site is a loan fund of £10,000 over five years with a 17% APR Representative rate. It would have an interest rate of 12% (fixed) and monthly repayments of £242.32. After five years, the total credit would be £11,040 (including interest and £1,040).
The service will calculate the origination fees and interest rate charged to you based on your circumstances.
Zopa is very selective about who they offer personal loans to – on their site. They say that only about 20% of people who apply for loan funds through them are accepted.
- Ratesetter
One of the main advantages of investing through Ratesetter is that they provide provident funds to reimburse you if a borrower misses a repayment.
But beware, it is not guaranteed that you will get back all the money you lose – if they can reimburse some or all of the money lost depending on the amount of the provident fund at the time. To build up the fund, they contribute to a reduction in interest on repayments.
Here are three products offered by Ratesetter to investors:
- Access (3%*)
- More (3.5%*)
- Max (4%*).
Ratesetter currently has a temporary interest reduction period, so if your interest is equal to the above rates (i.e., 3%, 3.5%, or 4%), the interest will be reduced by 50%.
When you invest money, your funds will automatically be matched to a loan agreement – you don’t choose who borrows the money.
Ratesetter allows you to subscribe to their Access, Plus, or Max products as an Innovative Finance ISA. This would allow you to earn tax-free interest on your investments, but you should note that it still does not have FSCS protection.
If you choose not to invest through an Innovative Finance ISA, you must declare your investment income for tax.
Ratesetter personal loans have interest rates starting at 6.9% APR. Loans range from £1,000 to £35,000 over one to five years.
As with all personal loans, people are rated by Ratesetter before being accepted or rejected for a loan. The company decides whether or not to take loan applications based on whether it thinks the applicant can afford repayments and their “creditworthiness” (credit history).
Advantages and disadvantages of peer-to-peer lending
Like all investments, crowdlending has advantages and disadvantages. Here is the overview:
Advantages:
- Potential returns
P2P lending offers investors high potential returns. Investments are divided into risk classes so the investor can weigh up risk and return. A private online lender can even get special online tools with which they can quickly get an overview and do not need any special knowledge.
- Sensible investment It is important to many investors that their money works profitably and serves a valuable purpose. With peer-to-peer lending, the investors know that they are supporting private projects.
- Transparency
Peer-to-peer lending is largely transparent and understandable. It is simple direct personal loans with fixed conditions compared to many other asset classes, which work so confusing that even bank advisors often cannot oversee the process.
- Opportunity for small investments
Investors can invest small amounts in peer-to-peer lending. This means that the investment is not only accessible to a wide range of investors but also enables uncomplicated risk diversification.
Disadvantages
- Risk of default
There is generally a risk of default with peer-to-peer lending.
This can result in a loss of principal and interest for the peer-to-peer lenders. To counteract this, investors should only invest in their desired asset class.
Who benefits, and how much should I invest?
As an investment opportunity, peer-to-peer loans make sense for anyone who can access disposable savings that are not needed for immediate living. Since conventional savings investments with fixed interest rates rarely bring significant returns. Peer-to-peer loans can be used to expand the investment spectrum.
With restrictions, it also makes sense to use personal loans for targeted savings. However, you should think carefully about which goal you are pursuing. For example, if you have to pay off your loan funds in about five years, a P2P investment is not particularly suitable.
On the other hand, if you are saving for a goal where the amount is variable and which you can do without in an emergency, an investment in P2P personal loans offers you excellent prospects. It could be a vacation or a new car.
If your investment does not exceed 5% of your total assets, you secure a strong return option with an overall calculable risk.
P2P lending for investors
With the help of peer-to-peer loans, private investors can put together an attractive portfolio of profitable asset classes. A credit platform, therefore, primarily fulfills the function of an intermediary.
For a small fee, which accounts for a few percent of the loan amount, compliance with the loan terms is monitored by both sides. Otherwise, the peer-to-peer lenders are entitled to take legal action. Peer-to-peer loans are worthwhile for investors because their interest rates are higher than at traditional lenders like banks or credit unions. It is even possible to finance a project with other investors.
In addition, a peer-to-peer lender can benefit from the fact that there are different risk classes into which personal loan requests are divided. As in the financial market, it is ultimately the risk that determines the potential return on investment of the peer-to-peer lender.
Peer-to-peer lending for borrowers
There is hardly an easier way to take out a personal loan than with a peer-to-peer marketplace. Blockchain is now in use in the financial industry. As a result, it’s faster and easier to get a loan. In addition, registration is free for investors and borrowers; origination fees only apply if the brokerage is successful.
Peer-to-peer lending makes lending much easier. For instance, to take a loan, you need to register with a platform and enter information about the desired loan amount and its intended use.
Investors can view these published listings and decide which to invest in.
Loan repayment follows the same scheme as a bank: the borrower transfers monthly installments back to the lender.
Investing money safely: How important is creditworthiness for peer-to-peer loans?
In most countries with peer-to-peer lending markets, the credit rating for peer-to-peer loans plays an important role.
Creditworthiness directly impacts a borrower’s ability to repay the loan. For example, peer-to-peer lending platforms use a borrower’s credit score and other financial information to determine the risk associated with lending money to that individual.
When you have a high credit score and a good credit history, you have a lower risk of default, and thus the borrower may be eligible for lower interest rates and better loan terms.
On the other hand, a low credit score or poor credit history can result in higher interest rates and reduced loan options. Hence, creditworthiness plays a crucial role in the approval and terms of a P2P loan.
But suppose you don’t get a loan from traditional financial institutions like a credit union or bank simply because of a bad credit rating. In that case, peer-to-peer loans from an online lender can be an alternative.
The prerequisite for this is that the applicant does not otherwise have any negative characteristics: If, for example, there is also a personal bankruptcy, the chances of a peer-to-peer loan are also poor.
Investors with a secure portfolio can often accept a more significant risk due to attractive interest rates.
Important questions
Can you also apply for a private loan as a self-employed or freelancer?
Yes. This is the great advantage of credit marketplaces: unlike many traditional lenders like banks, they also offer the self-employed or freelancers the opportunity to take out a loan.
What fees does the borrower have to pay?
This varies from provider to provider. In most cases, however, the origination fees for arranging the personal loan are only charged when the financing is achieved – e.g., in the form of a certain percentage of the net loan amount. The fee amount calculated as a percentage often depends on the peer-to-peer loan amount, the term, and the individual creditworthiness profile.
What can be financed with a P2P loan?
Personal loans can be used almost universally, whether a car loan, a new kitchen or diving equipment. However, the applicant sometimes has to declare their desire for financing in advance. The potentially possible personal loan amounts also vary between the credit marketplaces. We think P2P credit marketplaces are unsuitable for larger projects such as construction financing. They are, therefore, not an alternative to bank loans but a supplement. However, some peer-to-peer lenders like Funding Circle can borrow up to $500,000.
Where does the money come from in P2P lending?
P2P lending funds can come from traditional financial institutions or online traders. For example, for US-based P2P platforms, institutional investors finance 80 percent of the total volume of personal loans granted.
For instance, a University of Cambridge 2015 study shows that institutional investors granted 32 percent of P2P loans in Great Britain.
