Traditional forms of consumer lending exist at the institutional level. You visit a bank branch, apply for a car, personal, or student loan, and await the decision from the underwriters at the centralized office. This kind of lending often shuts out certain borrowers – whether or not bad credit is a factor – as financial industries are wary of any credit risk, regardless of other characteristics.
However, with peer-to-peer lending, the middleman is removed from the equation, and borrowers are teamed up with non-financial institution lenders who offer comparable interest rates and terms – all on an online platform.
As the future of lending, some argue, this type of direct-to-borrower business threatens institutional financial behemoths, much as how Uber directly threatens the institutional model of taxicabs.
What is Peer to Peer Lending?
Most peer-to-peer lenders offer a platform through which appropriate lenders are found for prospective borrowers. Instead of spending overhead on brick and mortar businesses, immense payrolls and staff, and bloated compensation packages for management teams, these streamlined businesses – many of which originate from the tech sector – offer slimmer overheads, and can thus keep rates and payments low for borrowers.
In addition, because of the lower overhead costs, both the borrower and the lender benefit. Those looking to borrow money enjoy lower rates (and subsequent payments) than traditional unsecured credit lines, and private lenders can see higher interest rates of return on their loan investment.
Types of P2P Lending
Most peer-to-peer lending is unsecured credit. These types of loans are usually unsecured personal loans, in varying amounts. However, another large component of the peer-to-peer business is student loans. In recent years, skyrocketing tuition costs and a rising influx of private student lenders (institutional) have left students in crushing, insurmountable debt.
Thus, with the more efficient, merciful peer-to-peer lending schemes, students have an alternative to bloated government loans or, at times, near-predatory private student loans. Peer-to-peer loans are sometimes secured loans when the item being financed is a luxury item like an expensive car, jewelry, fine art, or property.
Peer-to-peer companies are now also regulated, like many other financial institutions, and therefore borrowers and lenders have an extra degree of security over their investments and loans.
There are clear advantages to peer-to-peer lending. The first is the financial advantage and the sense of autonomy that comes with direct investment and lending.
Borrowers are often at the whim of massive, ruthless, capitalist machines when taking out certain types of loans. With a more direct communication between the tech interface and the actual lender, a sense of control and dignity is restored to the lending process.
A second advantage is for lenders. While traditional investing usually is oriented around the stock market, this avenue of lending offers an alternative, and sometimes safer, approach. For those lenders looking to diversify their portfolios, peer-to-peer lending can be a new pathway for generating revenue. Finally, peer-to-peer lending can weather financial crises.
During the 2008 financial crisis, many people turned to peer-to-peer lending to get funds for projects, homes, cars, and other necessities. While credit was frozen solid in the institutions, private lenders saw opportunity in the crisis, and borrowers were able to continue to finance their day-to-day purchases and bills.
Is It Right For You?
Peer-to-peer lending has a long way to go to truly threaten the major financial institutions. However, its growth is unmistakable.
In addition, the culture of democratized citizenship is giving fuel to the business model of peer-to-peer. By empowering regular citizens to help one another out financially, peer-to-peer businesses help push forward a model of sustainable, human growth that began with the now-giants of Airbnb and Uber.