What Is Peer-to-Peer Lending?
Peer-to-peer lending, also known as P2P lending or social lending, is the practice of packaging small amounts of money from different lenders to provide a loan to a borrower. With P2P lending, rates are usually lower than bank rates because there isn’t a middleman. Loan amounts range between $1,000 and $40,000.
P2P lenders can include:
Alternative asset managers
They view these kinds of loans as investments that pay a fixed interest rate. Lenders may pledge as little as $25 to many borrowers, which results in a portfolio of loans to help manage their risk.
How Does a Peer-to-Peer Loan Work?
Most peer-to-peer loans are unsecured personal loans that are transacted online through P2P lending platforms. These sites:
Collect and verify a borrower’s personal and financial information
Perform credit scoring and credit checking
Process monthly payments
Be aware that peer-to-peer loans aren’t FDIC insured, putting both lenders and borrowers at risk. FDIC stands for federal deposit insurance corporation. It helps protect a person’s account and money at certain financial institutions, like a bank. If a bank institution is FDIC insured, it means a person’s account is covered up to $250,000.1 So, if the bank goes out of business, the person won’t lose their money.
It's a good idea to check the terms and conditions of a peer-to-peer loan. Generally, these types of loans don’t have prepayment penalties, so you can pay the loan back earlier. But there may be loan origination fees or closing costs that can add to the total cost.
What Is P2P Lending Used For?
Historically, most peer-to-peer lending sites make loans out to individuals instead of businesses. In recent years, however, this trend is changing. According to the Small Business Administration, P2P lending is growing with online lending platforms filling a niche market for small business capital.
Business owners use P2P loans for a wide range of reasons, including:
Purchasing equipment and tools
Cover training costs for employees
Is Peer-to-Peer Lending Safe?
Because peer-to-peer lending isn’t FDIC insured, there are risks for lenders and borrowers. Lenders may not make as much of a return as expected, especially if a borrower defaults on their loan. Doing due diligence and researching peer-to-peer lending companies and platforms can help you avoid potential issues.
1 Federal Deposit Insurance Corporation, “Insured or Not Insured?”
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