Marketplace lending, sometimes called ‘Peer-to-Peer’ (P2P) lending, was among the earliest innovations to contribute to the FinTech revolution of today. And in recent years, the online-lending industry has exploded. In 2015 alone the P2P industry generated $6.6 billion in loans. Furthermore, this growth is global with the UK and Europe quickly catching up to the U.S. Amid the Trump administration promising to relax regulations, it’s unlikely that this growth will abate any time soon.
This lending option circumvents the traditional relationship between a brick and mortar bank and the individual borrower. How does it work? Lenders and borrowers connect over one of the dozens of marketplace lending sites. As a result, the process is fast, convenient and cheap. But just how much cheaper is it to secure a personal loan through P2P financing compared to a conventional bank loan? Let’s take a closer look.
Costs Associated With Traditional Bank Loans
Since the early 1980s, the finance rate on personal loans at commercial banks for a 24-month loan has steadily dropped. At its height in 1981, the average reached 19.21%. Today, borrowers can expect to pay 9.45% according to the Federal Reserve Bank of St. Louis. However, many borrowers will face a higher rate given the average U.S. credit score of 695. At this score, a borrower will likely face an interest rate of 13.5% to 17.5%. Accessing these rates means having a minimum FICO score of 660 in many cases.
Paying off a personal loan carries other costs beyond the interest rate. Some lenders sneak in extra costs which boost the borrower's total expense. For example, some loans use pre-compute interest. In this case, the bank penalizes the borrower with more interest for paying off a loan earlier than scheduled. Others attempt to package an insurance plan with the loan. Finally, the most common unexpected expense is the origination fee. Nearly all loans include this cost. However, many forget to account for it when planning their finances. Remember, the origination fee is deducted from the loan amount. Therefore, if you borrow $15,000 at a 2% origination fee, you are only getting $14,700. Origination fees can reach as high as 6%.
Costs Associated With Peer-to-Peer Loans
There are dozens of choices for P2P borrowers. LendingClub and Prosper are among the most popular. However, many more options exist. Online lenders offer speed and flexibility that is not possible with traditional banks. Those in good credit standing can access capital for as low as 5.7% making the loans more competitive than the neighborhood bank.
Some of the most competitive providers like SoFi and Discover Personal Loans require no origination fee and users can borrow up to $100,00. Additionally, there are no prepayment fees. In short: P2P loans offer a more competitive interest rate with ample borrowing limits at no origination fee. If we compare a borrower with a strong credit score at a bank versus an online lender, then the rates are 9.45% and 5.7% comparatively. Moreover, the absence of fees makes the savings even better.
Why P2P Loans Can Be Cheaper
Both conventional personal loans and P2P loans are unsecured, meaning the loan is not backed by the borrower's assets. Resultantly, banks deal with this risk by charging high-interest rates. In doing so, they ensure that the income they do receive offsets or exceeds the cost of writing off bad loans.
Peer-to-Peer lending is different because the institution, the middle men has been removed making the overall process less expensive. Traditionally, the task of running credit checks, filing papers, and completing applications drove up the cost of lending. Marketplace lending streamlines this protocol, so decisions come faster and with less expense. Additionally, emerging technologies and algorithms have equipped P2P lenders with more sophisticated ways of measuring an applicant's ability to repay. This analysis results in fewer defaulted and delinquent loans. The result is a cheaper business model where savings are passed on to the borrowers.