Let’s Talk About Peer to Peer Lending

Let’s Talk About Peer to Peer Lending

All of us have watched commercials for different banks over the years. They promise to provide friendly service, quick answers to your problems, and a loan for anything that you need. Banks, also at one time, provided certificates of deposit (CDs) and savings accounts that paid 5-10% per year. A lot of older people, including my grandparents, put a lot of their money in these entities and lived off of the interest for their retirement.

Unfortunately, those days are gone. Think about the recent revelations with Wells Fargo and different banks (not all banks are bad, I prefer credit unions), along with the fact that CDs are at best paying about 1% maybe 2%, not even enough to keep up with inflation. So you are losing money if you put it in the bank.

So where can you go for loans and/or investment products that might suit your needs: Try Peer to Peer Lending.

What Is Peer to Peer Lending?

Peer to Peer Lending is, in essence, peers (people like you and me) who loan money to people with various credit ratings for specific projects. You can’t get mortgages with P2P lending. However, you can get, according to some companies, up to $40,000 for a specific project.

The major players in P2P lending are Lending Club and Prosper (I don’t get any money mentioning those companies). There are also other players that are coming into this market as well, but Lending Club and Prosper are the most famous at the moment.

Here is how it works. Let’s say you have credit card debt or other debts that have high interest rates, but you don’t have equity in your home or cash to pay for the debt or good credit to get a normal loan (lots of people with great credit also use P2P lending). In other words, you have a lot of unsecured debt. Unsecured debt is debt that doesn’t have anything backing it (e.g. a car, a home, etc). Credit cards are the most famous form of unsecured debt. Anyway,  the banks won’t lend to you or you can’t get the cash available you can go to a place like Prosper or Lending Club and submit a loan application.

You submit a loan application for $10,000. In that application, you must lay out your debts, your income, and the like to demonstrate you can pay back the loan. Depending on your creditworthiness will determine your interest rate and whether your loan will be funded.

How Does the Loan Get Funded?

Let’s say that your application is approved and you receive an interest rate of 6%, which can be better than many banks for a loan that is unsecured.

What happens then is that hundreds, if not thousands, of people look at your application and they basically buy small shares of your loan. For example, it is not unusual to have on a 10k loan over a few hundred people funding that loan. Each person contributes as little as $25 so that you can fund the loan. The peer lenders get paid pack by you making payments on the loan that includes interest.

Now there are different grades to loans. The more credit worthy you are, the better income, less debt, etc the better your interest rate will be. If you have less income, a larger loan, more debt than your credit worthiness is less and your loan is “graded” differently. Your interest rate will go up.

However, peer-to-peer lending can be a place to go if you need to obtain a loan for a project or debt consolidation.

Remember, this isn’t free money. You will be charged an interest rate and you MUST pay back the loan. However, if you are tired of dealing with banks or need another alternative P2P lending could be an answer.

*Full disclosure: I have used Lending Club before for a project and I paid the loan off early. I am now thinking about becoming an investor, not a debtor.

How to Become an Investor

So above I discussed P2P lending regarding how to use it if you need a loan. However, you can also become the bank in a sense. Mr. Money Mustache has a great post on this experiment.

In essence, it works like this. You open up an account at one of the P2P lending sites. You must obviously put money into this investment (I can’t remember what the minimum is, but I think it is pretty low). Then what you do is for as little at $25 you can buy “shares” of different loans.

Different loans, as I mentioned, are graded differently and the greater the risk. If you are looking to be a bit riskier then you can invest in loans with larger interest rates and greater risk, but better returns. If you want to be a bit more conservative then you can invest in A graded loans only. You get to pick.

Now you don’t have to buy every loan out there. You can pick and choose by hand or kind of like a mutual fund, you can pick a basket of loans (different mixes of risk) that will be invested for you (I believe).

Depending on your level of risk is what your returns will be.

Now there are some people who do default on their loans, but according to these P2P lending sites the default rates are actually similar or even better than most banks. So yes there is some risk, but you would have a similar risk by investing in stocks potentially.

What I think is potentially great about P2P lending is that it allows normal people to get involved. The banks don’t control the situation and you can get a better return on these items than with a Bank CD.

The return is not guaranteed of course. And I recommend you spend some time investigating this stuff even more. Read up on P2P lending the benefits, risks, etc.

However, if you are looking for income. If you are looking for diversification in your portfolio. If you are looking for a new way to fund loans or to become an investor. P2P lending could be right for you.

 

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