What is Peer to Peer lending?

Peer-to-peer lending often referred to as P2P lending is the practice of lending money, via a website, to unrelated individuals, or ‘peers’ without the borrower going through a traditional financial institution like a bank or building society. 

Most peer-to-peer loans are unsecured personal loans, and are made to an individuals but there is growth in P2P lending to businesses, as availability of credit is still restricted in many markets. And generally borrowers do not provide collateral as a protection to the lender.  

The interest rates are set either by lenders who compete for the lowest rate on the reverse auction model, or are fixed by the intermediary company on the basis of their analysis of the borrower’s credit, but the reverse auction model appears to be preferred method currently. Borrowers deemed as having a higher risk of default are assigned higher rates. Lenders in turn, mitigate the risk of borrowers failing to repay the loans by choosing which borrowers to lend to and by diversifying lending investments among different borrowers.

The lending intermediaries are for-profit businesses; and earn revenue by collecting a one-time fee on funded loans from borrowers and assessing a loan servicing fee to investors, either a fixed amount annually or a percentage of the loan amount. Because many of the services are automated, the intermediary companies can operate with lower overhead and provide the service cheaper than traditional financial institutions, so that borrowers may be able to borrow money at lower interest rates and lenders earn higher returns.

Key characteristics

  • conducted for profit
  • no requirement for prior relationship between lenders and borrowers
  • intermediation by a peer-to-peer lending company
  • transactions take place on-line
  • lenders choose which loans to invest in
  • loans are unsecured and often un-protected  
  • loans can be securities that be sold to other lenders

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