What are P2P loans — and should you get one?
About peer-to-peer (P2P) loans
- Connects borrowers with individual investors.
- Investors aren't guaranteed; you may not attact enough backers for a loan.
- May be more accessible to people who don’t qualify for bank loans.
- May come with higher interest rates than bank loans.
- State laws on P2P vary, and not all states allow P2P.
You may have heard a lot about peer-to-peer (P2P) lending or heard talk about some of the major P2P lending platforms, such as Lending Club, Prosper and Upstart.
P2P loans are different from a traditional loan from a bank in that the loans are funded by dozens of consumer investors rather than by a single financial institution. Some P2P loans may be funded by as many as 100 individual investors.
Essentially, P2P platforms connect borrowers directly with individual investors. The loans are spread over many investors to help them diversify their investment and minimize their risk in the event that a borrower defaults on the loan.
Although P2P lending is similar to crowdfunding, the two terms shouldn’t be confused. Crowdfunding is a way for people to raise money from lots of people to fund a certain project, but the money isn’t a loan and doesn’t have to be paid back. P2P loans, however, are just what they sound like: loans that need to be paid back with interest.
Loan amounts generally range from $1,000 to $36,000, with the exact limits differing between lending platforms.
One of the main advantages of P2P loans over traditional bank loans is that you are more likely to be approved. While banks have tightened their requirements to be approved for a loan since the financial crisis, P2P lenders, because they’re typically run entirely online and have less overhead, can extend credit to people who would be turned away by the banks.
Additionally, because of the low overhead costs, P2P lenders can offer relatively low interest rates — as low as 7 percent for borrowers who have excellent credit. P2P loans can be a good option for creditworthy borrowers trying to consolidate debt.
Even P2P interest rates on the higher end of the spectrum for solid borrowers, around 15 percent, may be lower than credit card debt, which can carry interest rates running as high as the 20 percent range. For riskier borrowers, however, Lending Club’s interest rates go as high as 24.63 percent, and Prosper’s are as high as 35.36 percent.
Although it’s rare, it is possible that even if you are approved for a loan by a P2P lending website, not enough investors will come forward to fund the loan.
Keep in mind, also, that although interest rates for P2P loans can be relatively low for borrowers with good credit, they are still higher than they would be with a comparable loan from a bank. Even so, they can still be a good option for consolidating debt, or as an alternative to very high-cost personal loans, such as payday loans.
Interest isn’t the only cost associated with taking a loan from a P2P lender. Most P2P lenders charge an origination fee. In addition, be aware that other charges and fees can pop up throughout the life of the loan, such as late fees.
Another disadvantage is that you may not even qualify for a P2P loan, depending on your credit score. Although many factors go into the qualification process, many P2P lenders will not approve a loan unless you have a credit score of at least 640 — although the exact number varies by lender.
Additionally, each state has its own laws affecting P2P lending. Consequently, P2P lending is not available in some states.