Peer-to-peer lending (also known as “social lending”) allows borrowers to bypass the involvement of a traditional lending institution and take out loans directly from other individuals. You can take out a peer-to-peer loan from someone you already know or you may apply for such a loan from an online lending marketplace, such as Prosper.com. Peer-to-peer lending makes it possible for borrowers to take out loans when they may not qualify with traditional banks. These loans tend to be for a shorter duration and have higher interest rates than bank loans.
How Peer-to-Peer Lending Works
Several peer-to-peer lending websites allow users to deposit money into a special account. A borrower appeals publicly to prospective lenders by submitting information about himself, his financial situation, and the purpose of the loan. The borrower may select an interest rate he is willing to pay or the site may select the interest rate based on the current market and the borrower’s financial information. If enough users decide to lend their money to a particular borrower, his loan will go through. Peer-to-peer lending companies usually make money by charging both lenders and borrowers a percentage of each transaction.
Another type of peer-to-peer lending occurs directly between friends or relatives. Many borrowers are able to take out a loan from a generous associate – often with a very low rate and no financial background check. Although it is not required, it is often a good idea to have these loans written down and notarized. Lending companies such as Virgin Money help friends and family formalize their loans and can even provide services such as repayment schedules and year end statements.
How to Qualify for Peer-to-Peer Lending
Taking out a loan on a peer-to-peer lending site is very different than taking out a loan from a traditional bank. Most sites require borrowers to give specific information such as their income and their expenses. Credit checks reveal the borrower’s score, debt-to-income ratio, and financial obligations. In most cases, none of this information will automatically exclude a prospective borrower. Site users will see this information, but the borrower also has an opportunity to explain any potential problems. For example: a borrower might explain that a poor credit score is due to unpaid medical bills after a serious accident. Users can decide if the borrower is worth the risk.
Benefits of Peer-to-Peer Lending
Peer-to-peer lending can be a smart choice for borrowers who need short term cash. The ability to explain credit report issues makes it possible for some borrowers to get money that they wouldn’t normally qualify for.
Risks of Peer-to-Peer Lending
Interest rates on peer-to-peer loans can be very high, especially for borrowers with less than perfect credit. Paying over 30% can be a poor financial decision – many credit cards offer rates lower than that. Loans are also for a short period of time, such as three years when using Prosper.com. Keep in mind that the lender will keep some of your loan funds as a fee, reducing the total amount of money you have available and increasing your actual interest rate.
Traditional mortgage lenders may not allow peer-to-peer lending funds to be used as a property down payment. However, it may be possible to use the funds for other purposes in order to save your actual income for a down payment.
Where to Find Peer-to-Peer Lenders
To find peer-to-peer borrowing sites, check out our List of Peer-to-Peer Lenders.