A Quick Guide to Peer Lending [2019]

Peer lending is relatively new to the financing scene, but it’s actually not that complicated.
10/4/19 | By Jennifer Calonia
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As much as you try to prepare financially, you might find yourself in need of a small, short-term loan. Traditionally, banks and credit unions have been the go-to option when you need to take out a personal loan, but now there’s another alternative.

Peer lending has gained traction as a reliable way to remove middleman financial institutions by borrowing directly from another person. Find out how peer lending works, its pros and cons, and whether it could be a good option for you.

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What is peer lending, and how does it work?

Peer lending goes by a few other names, like peer-to-peer lending or platform lending, but these are ultimately the same. This financing option is available to individual borrowers as well as small businesses.

As a borrower who’s looking for a loan, you’ll be matched to an investor (or multiple investors) interested in investing their money toward your loan. Some investors may also choose to buy your existing loan, if you want to refinance to more favorable terms. This entire transaction is done through an online lending platform.

If your request for a loan is funded, you’ll receive a lump sum for the amount you borrowed. Then you’ll make payments toward the loan, plus interest, as you’d make on a traditional personal loan. The platform then routes the principal and interest payments, minus platform fees, to the investor.

If you need a loan and want the convenience of a fast and easy online application, as well as a potentially lower cost of borrowing, peer lending might be right for you.

The pros of peer lending

From a borrower's perspective, peer-to-peer lending has many benefits. The first is that interest rates on a peer-to-peer loan may be considerably lower than rates on other convenient lines of credit, like credit cards. For example, according to the Federal Reserve, the average credit card interest rate as of 2019 is about 17%. Conversely, peer lending platforms like Upstart boast rates as low as 5.67% for qualified borrowers (as of Oct. 2, 2019). Some borrowers may then see significant savings by participating in platform lending.

Another advantage that peer lending affords its borrowers is a faster way to get funds in hand, since the borrower and investor work together through the platform to come to agreeable lending terms.

Unlike a traditional bank that may have stringent requirements when it comes to approving a loan application, peer lending platforms may be less strict. For example, in addition to your credit score and history, Upstart also uses your education level and employment history when approving you for a loan and determining the interest rate offered to you.

The cons of peer lending

Peer lending platforms also have their share of disadvantages. The first is that peer platforms may have a limit for how much you can borrow. For example, LendingClub, one of the largest peer lending platforms, offers a maximum of $40,000 for a personal loan.

And although peer lending platforms might look at more than just your credit score to determine your risk as a borrower, you still may not be approved if you have poor credit. Although rates for peer-to-peer lending often start off lower than other lines of credit, they can still be steep for borrowers who are considered high risk. For example, Upstart’s rates can be as high as 35.99% (as of Oct. 2, 2019).

Common questions about peer lending

Is peer lending safe?

Many of the risks related to peer lending fall on investors’ shoulders, rather than the borrower. Although peer lending platforms are regulated by the Securities and Exchange Commission (SEC) and state regulators, notes are not government-backed by the FDIC (Federal Deposit Insurance Corporation) or NCUA (National Credit Union Administration).

This means that if a borrower defaults on their loan, investors may not be legally able to get their investment back.

What are the best peer lending platforms?

Figuring out the best peer lending platform for you depends on how much you need to borrow, origination fees associated with the platform, the interest rate you qualify for, and other factors.

Some platforms charge origination fees as high as 6% and might require a higher loan minimum than you actually need to borrow. Prosper, another well-known peer-to-peer lending platform, offers a minimum personal loan of $2,000, for example. If you only need a $1,000 loan, this may not be the right platform for your needs. When comparing options across peer lending platforms, it’s important to weigh how much the loan will cost you and what you can realistically afford to borrow.

How much can I borrow from a peer lending site?

The amount you can borrow toward a personal loan depends on the platform. For example, LendingClub offers loans from $1,000 to $40,000, but the amount you’re approved for is based on factors like your credit and ability to repay the loan.

Will a peer-to-peer loan negatively impact my credit score?

When shopping for a personal loan through a peer lending platform, your credit score isn’t adversely affected. The platform conducts what’s called a “soft credit check,” which allows you to compare rates across different peer-to-peer platforms without the risk of lowering your credit score.

If you decide to accept the loan offer, the lending platform then performs a “hard credit check,” which can temporarily affect your credit score.

What to consider about peer lending before you apply

Before applying for a peer-to-peer personal loan, ask yourself a few questions:

1. Why do you need a loan?

Peer lending can be a convenient way to fund financial gaps when you’re short on money. However, it’s still a loan that you’re ultimately responsible for repaying over three or five years.

Decide whether the reason for taking on this debt is necessary and if there’s a way to avoid a loan. If your reason for borrowing money, for instance, is to help pay for wedding expenses, find ways to cut costs. Consider lowering your guest count or serving well drinks instead of top-shelf cocktails.

2. Can you afford a loan?

Affording the cost of a loan can feel manageable when payments are broken down into small monthly payments over a few years. But don’t lose sight of the big picture, including your day-to-day expenses and available income.

When comparing loan offers, calculate how much a loan, plus interest and fees, will cost you. Then calculate each amount against your existing financial responsibilities to ensure you can afford to repay the loan.

Like with a traditional personal loan or line of credit, if you miss payments or fall into default, it may have long-term implications on your credit. This could impact your future goals, like buying a home.

3. Is your credit strong enough to get approved?

Having poor credit may result in less competitive rates and terms on a peer-to-peer loan. You may not even get approved if your borrowing profile is considered too high-risk.

Before shopping around on peer lending platforms, know where your credit stands. You’re entitled to a free annual credit report from each of the three credit bureaus, which you can request at AnnualCreditReport.com.

4. What are your other options?

If you’re confident that you have strong credit, you may have other affordable options available to you. For example, if you only need to borrow a small amount, see whether you’re pre-approved for a promotional zero-interest credit card.

Some 0% credit card promotions are available for the first six months of opening a new account, up to as long as 18 months. Just remember to mark your calendar and repay your card’s balance in full before the promotional rate expires.

5. What are you giving up with a peer-to-peer personal loan?

Some borrowers use peer lending as a way to refinance their existing loans. Before signing on the dotted line, make sure you know exactly what you’re giving up by refinancing through platform lending.

For example, it may seem tempting to refinance federal student loans if you think you can get a lower refinancing rate. By refinancing federal loans, however, you’re relinquishing borrower protections, like access to income-driven repayment plans, student loan deferment, and forbearance options.

How to get started with peer lending

If you’re still certain that peer lending is right for you, make sure you shop around with various reputable platforms, like LendingClub, Prosper, and Upstart. By providing your basic information, details about your loan needs, income, and existing debt, peer lending platforms can run a soft inquiry into your credit to help you understand your loan options within minutes.

Although the process from applying for a loan to receiving the funds can seem quick, consider your options closely. Evaluate the amount you’re borrowing, the rate you’re offered, and how much time you have to repay the loan, as well as any origination or late payment fees. Doing your due diligence beforehand can help you feel confident that you’re making the right choice.

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