What is P2P Lending and How does it work?
Peer- To- Peer lending which is also called P2P lending is a method of lending money to individuals or businesses over an online platform that matches lenders with potential borrowers. It is a modern practice to the borrowing and lending experience. By eliminating banks, borrowers can access funds more quickly and investors can substantially earn better returns than that from traditional lending Instruments offered by traditional banks.
Peer- To-Peer lending
On the stage of popular innovative technologies, P2P lending is building acceptance among people. This form of lending benefits both the borrowers and lenders. P2P lending permits individuals to avail loans directly from other individuals while eliminating financial institutions as middlemen. These loans are availed by borrowers from the lenders through a secured online platform. Borrowers apply for loans on a suitable peer-to-peer lending platform and investors get to see and select exactly which loans they would want to fund.
P2P lending tenders both secured and unsecured personal loans. However, the loans offered by many platforms are unsecured personal loans. Since secured loans are generally staked by luxury goods. For example, artwork & collectibles, luxury cars, and high-end jewelry. These items can be used as a form of loan collateral.P2P offers a better rate of return to the investor, it is not just remunerative, but also has less hassle than complicated investments like stocks or shares.
Secured Loans– This type of loan is backed with something of a value that an individual owns. This is called collateral.
Unsecured Loans– An unsecured loan is a loan an individual borrows without any security or collateral.
Peer-to-Peer lending platforms are good substitutes for payday loans or credit card borrowers as it relies on individuals’ credit to earn competitive interest rates. However, borrowers with lower credit scores are likely to see higher interest rates. Despite the risk involved, investors in P2P lending have claimed on getting better returns on their investments than they would with other investment opportunities such as RBI taxable bonds, Gold ETF.
How Does It Work?
Peer-To-Peer lending is an easy and simple process, which uses an online platform to match lenders with borrowers. These platforms set the rates, terms and facilitate the transactions. Many online platforms have an extensive range of interest rates, which depends on the creditworthiness of an individual.
Below is the step-to-step guide to the P2P lending process.
- A Borrower interested to apply for a loan on a P2P lending platform has to first fill out and complete an online application.
- The online platform then evaluates the borrower’s application and determines the credit rating and risk of the borrower. Post that the borrowers are offered substantial interest rates.
- Once the application is approved, the borrower gets the available options for the investors, depending on his credit rating and sets apart interest rates.
- At the funding stage, the investors review the loan listings and fund the loans in increments.
- After the loan is successfully funded, the borrowers are moved to the repayment stage where the applicant is liable for paying periodic interest payments and repaying the principal amount at maturity.
- Every repayment made by the borrower is divided among various lenders, who receive the proportional share of the borrower’s payment.
The investors or lenders have an added advantage of choosing the kind of borrowers they wish to lend based on- borrowers who fall under excellent, good or fair credit rating. Or on the basis of different interest rates, and levels of risk. For example, the interest rates are substantially higher if a lender lends to a riskier borrower.
The investors invest their capital for a certain period and receive returns on their investment and get back their initial capital invested once the term ends.
P2P lending platforms charge fees to both lenders and borrowers. So it’s essential for both the parties involved in the lending platforms to analyze and scrutinize the terms of the platform before they accept or invest in a loan.
Pros and Cons of P2P lending
P2P lending provides a few substantial pros and cons to both borrowers and lenders
- P2P lending offers higher returns to investors when compared to other traditional forms of investments.
- It is termed as the most convenient source of funding for some borrowers than conventional loans from banks.
- P2P lending comes with lower interest rates due to the competition between lenders.
- P2P loans are “susceptible” to high credit risks. As many borrowers who apply for P2P loans have low credit ratings which do not allow them to borrow loans from banks, hence, the lender has to be aware of the default contingencies from their respective counterparts.
- In case the borrowers default in making payment, the government does not provide insurance or any form of safety to the lenders.
Therefore, P2P lending caters to a different platform for both borrowers and lenders to gain outcomes from the technology-driven financial model. In order to earn a competitive return, investors should invest for a longer time. However, many P2P platforms allow you to withdraw the money earlier for a fee, therefore it’s suggested to keep it invested for a longer time as much as possible in order to maximize profits and earn higher returns this way. Hence, individuals should not commit to any loan until they have gauged and reviewed other options.
RBI has set aside certain rules and regulations in transacting P2P lending in India. With the right guidelines in place, the future of P2P lending in India looks bright!