Peer-to-peer (P2P) lending has started gaining prominence in the past years as an alternative to traditional banking systems. It allows people to lend money directly to other individuals or small scale businesses without involving banks or other financial institutions. Investors can lend money to borrowers using online platforms and in return, they receive interest on their investments.
Peer-to-peer lending definetly offers great opportunities to borrowers and lenders. But it does come with certain risks. This article aims to discuss the advantages and disadvantages of P2P lending to assist you in determining if it is the right decision for you.
What is P2P Lending?
It is a type of online lending model that connects individuals looking to borrow money with investors willing to lend. P2P lending platforms do not operate on a traditional way as banks do. They do not provide loans from their own reserves and take deposits for them. They connect borrowers and lenders, acting as an agent and charging a service fee.
Loans from P2P platforms can be used to pay medical bills, consolidate debts, fund a small business, or even as home improvement loans. Many borrowers opt for P2P lending when they cannot obtain a loan from other traditional financial institutions, and many lenders put their money to work because they want a better return on investment than savings accounts or bonds.
Advantages of Peer-to Peer Lending
- For Borrowers: Easier Access to Credit
One of the key benefits of П2Р lending has to do with its perceived accessibility that provides access for easier credit to individuals and businesses. Those who have low credit scores wouldn’t be able to secure loans from banks, but would usually be able to get funding through a P2P platform.
P2P lending considers all aspects of a person’s life, and that approach makes it easier for many borrowers that are turned away by other lending institutions. Other platforms also check the borrower’s credit score, but many take a much narrower perspective on the borrower’s economic situation. People that are deemed almost loan worthy are able to secure loans and meet repayment timelines will receive funding.
- Lower Interest Rates P2P lending has proven to be a feasible option for borrowers and investors given the competitive interest rates when compared to traditional banks. For borrowers, this means there is lower interest paid on loans, especially for those with good credit scores. On the lender side, investors seem to earn more with regard to interest in comparison to other low risk investments like savings accounts or bonds. This proves to be beneficial for people who want to explore investment opportunities with greater returns.
- Diversification for Investors Peer to peer lending provides investors with an excellent opportunity to diversify their portfolios beyond the typical investments such as stocks, bonds, and real estate. Lending money through a P2P platform allows the investors to distribute their risks across numerous loans and thereby minimizing the default risk with a single borrower. Customization enables investors with the freedom to align their investments with personal financial goals. Many P2P platforms give the investors freedom in choosing the type of loans that they want to fund such as personal loans, business loans, or student loans.
- Convenience And Accessibility Most peer-to-peer lending platforms are straightforward and highly convenient. Online, borrowers can apply for loans while lenders can peruse various loan listings and select the loans they wish to fund. Usually, the process is quicker than that of mainstream banks and often completed online, making it available from anywhere at any time.
- Transparency Transparency in relation to P2P Platforms is well catered for both buyers and investors. Borrowers can access interest rates, terms of a loan, and the fees of various lenders. Investors are given detailed information of the borrower ranging from his credit score, income, and the purpose of the loan. This allows both lenders and borrowers to make decisions that are well informed.
- Risks of Peer-to-Peer Lending
With P2P lending’s advantages, there are drawbacks that need to be highlighted concerning the risks of the borrower and the lender.
- Risk of Default There are various drawbacks that come with P2P lending, but one of the most considered is the risk of default. Since many borrowers are evaluated from unorthodox credit angles, there is always that chance that a number of them will not pay back their loans, especially if, at any point, they run into financial hardships post-loan.
For lenders, this indicates that they may forfeit receiving the guaranteed interest payments and even the principal investment amount. Although most P2P platforms provide loan-grade ratings to assist lenders in evaluating risk, defaults persist unabated, and borrowers may not repay the loan.
- Lack of Regulatory Oversight
When assessed against conventional banking systems, P2P (Peer-to-Peer) lending platforms are less regulated. While some countries have set up guidelines for P2P lending, others have yet to devise comprehensive legislation to regulate these platforms. This regulatory void heightens the risks of fraud, malpractice, or complete platform failure.
Furthermore, investors need to be careful with these platforms that do not defend the security of their investments. Unlike banks which are backed by insurance from government institutions like FDIC in the United States, P2P lending platforms usually do not provide similar financial cover.
- Illiquidity of Investment
P2P lending investments are more illiquid compared to stocks and bonds. This means once money is lent to a borrower, it becomes very difficult to retrieve or liquidate the investment. Due to the time-consuming nature of the process, investors are required to wait for the repayment of the loan, which extends over several years depending on the term of the loan.
This might create complications for investors requiring immediate liquidity. Some P2P platforms enable investors to sell their loan shares on a secondary market, but such trades might incur extra charges, and in certain cases, they may not even be feasible.
- Platform Risk
Platforms hold inherent risks of failing entirely. As P2P lending platforms serve as middlemen, if any one of them were to shut down, it would put its business on the line. Investors lose access to their investments entirely and in the case of platform shut down, borrowers are still bound to repay their loans. For the rest, getting money out of an investment becomes next to impossible.
It is highly likely that some of the platforms offer an alternative, but investors, before making any substantial investment, need to meticulously analyze the platform’s credibility and check their financial growth pattern.
- Fees and Costs Most P2P lending platforms charge users some fees for servicing their accounts. These fees may include origination fees for borrowers and servicing fees for investors. Even though these fees are lower than those for traditional banks, they can still cut into the returns. Also, if you want to sell your loan share on a secondary market, there might be other fees.
Conclusion
There is no doubt that Peer-to-peer lending creates a unique possibility to borrowers and investors alike since it gives easier access to credit, interest rate competitiveness, and diversification of investment opportunities. It’s very important to note emersion risks such as borrower’s defaults, neglect of regulatory supervision, illiquid nature, platform bankruptcy, and fees associated.
As with any financial decision, always be careful while doing background research on the P2P lending platforms, assessing your risk taking ability, and understanding what role this investment plays within your whole finances. After evaluating the benefits and risks, you will ultimately decide whether or not the peer-to-peer lending is suitable for you.