Peer-to-Peer (P2P) Lending: What Is It? How Does It Work?

Peer-to-Peer (P2P) Lending: What Is It? How Does It Work?

Peer-to-peer lending is a popular alternative to taking out a traditional loan from a bank. Most peer-to-peer loans are personal loans, which borrowers can use for a variety of purposes from debt consolidation to home improvement, or small business loans.

What Are Peer-to-Peer (P2P) Loans?

Peer-to-peer lending works differently than getting a loan from a bank or credit union. When you get a loan from the bank, the bank will use some of its assets, which are the deposits made into accounts by other customers, to fund the loan. With peer-to-peer lending, borrowers are matched directly with investors through a lending platform. Investors get to see and select exactly which loans they want to fund. Peer-to-peer loans are most commonly personal loans or small business loans. Peer-to-peer lending is also called person-to-person lending or social lending, and companies that make peer-to-peer loans are commonly called peer-to-peer lenders or marketplace lenders.

Some marketplace lenders place restrictions on what types of people can invest in their loans. Some companies, such as LendingClub and Prosper, are open to everyone, so long as you meet the account minimums. Other companies may only be open to accredited investors or qualified purchasers. Individuals are considered accredited investors when they have personal income of $200,000 ($300,000 for joint) for the last two years, or a net worth exceeding $1 million, either individually or jointly. Qualified purchasers must meet even greater requirements than accredited investors, owning at least $5 million in investments. Finally, some marketplace lenders are only open to institutional investors, such as hedge funds, commercial banks, pension or endowment funds and life insurance companies.

Marketplace lenders generate revenue by charging fees to borrowers and taking a percentage of the interest earned on the loan. Most commonly, lenders will charge origination fees, typically 1% to 6% of the loan amount, and late payment fees to borrowers. On the investing side, lenders will take a percentage of the interest accrued on the loan. LendingClub, for example, takes a 1% fee of each payment amount. If a borrower makes a $200 payment on a loan, LendingClub would take $2 before passing the payment on to investors.

Pros and Cons of P2P Lending

Peer-to-peer loans are not for every borrower or every investor, as they carry a unique set of advantages and disadvantages.

  • Fast, online experience
  • Lower range of interest rates
  • Fixed monthly payments
  • Can check rate without affecting credit score
  • Credit requirements may be less strict than at a bank
  • Most loans are unsecured
  • Flexible use of funds
  • Automatic repayment
  • No prepayment penalties
  • High interest rates up to 36% if you have below average credit
  • May be unable to qualify if you have a credit score below 630
  • Cannot usually borrow more than $35k to $40k
  • Some sites have high fees, including origination fees up to 6%
  • Missed payments will hurt your credit score
  • Higher yield than savings or CD accounts
  • Access to alternative investments outside of stocks and bonds
  • Most platforms allow you automatically diversify your loan portfolio
  • Sense of community or social good by lending directly to peers
  • Risk of losing your money if borrowers default
  • Not FDIC insured like a savings or CD account
  • Less liquidity than stocks or bonds because of long time horizons (three to five years)
  • Relatively new industry could mean more instability
  • Some sites are only available to accredited investors

P2P Lenders

We’ve compiled a list of marketplace lenders in the U.S. that are available to investors. The major lenders available to everyday investors are LendingClub and Prosper.

LenderTypes of P2P LoansWho Can Invest?
LendingClubPersonal loans, business loansEveryone
ProsperPersonal loansEveryone
UpstartPersonal loansEveryone
KivaMicroloans (non-interest bearing)Everyone
PeerformPersonal loansAccredited investors
Funding CircleSmall business loansAccredited investors
StreetSharesSmall business loansAccredited investors
ApplePie CapitalSmall business franchise loansAccredited investors
SoFiPersonal loans, student loan refinancingQualified purchasers
AvantPersonal loansInstitutional investors

How to Apply for a P2P Loan

Many marketplace lenders will let your check your rate and apply online. Typically, applying will only take a few minutes. Each lender will have different requirements. For personal loans, this includes your credit score, debt-to-income ratio, salary, employment status and credit history. For business loans, this includes your time in business, personal and business credit score, your debt service coverage ratio, revenue and profits. However, most lenders will only make loans to borrowers who are at least 18 years old and reside in a state they serve. You will also need a verifiable bank account and a Social Security Number.

In general, you’ll need to provide the lender with personal information, such as your name, address, birthdate, phone number and email address. For personal loans, you will also need to provide information on your housing or mortgage payments, other outstanding debts, employment status and salary, educational history and details on the loan you’re seeking. You may be required to verify some of this information through a photocopy of your I.D., pay stubs or W-2 forms. For business loans, you will need to provide information about your business financials and you may be required to submit documentation such as tax returns, balance sheets and profit and loss statements.

Once you submit an application, a lender may present you with a variety of loan offers. If you select one of these offers, you will generally need to submit to a hard credit check, which can affect your credit score. Most peer-to-peer lenders are quick to give you a loan decision, either same day or within a few days. Funding is also quick, with most borrowers receiving funds within two to 14 days.

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.