Peer to Peer Lending Review: What is It and How Do You Make It Work for You
Lately there’s been a lot of talk about crowdfunding and sites like Kickstarter that have been used to fund independent films, tech gadgets, and even the return of Reading Rainbow. These sites collect donations towards a monetary goal in exchange for various incentives chosen by the project’s host. Similarly peer to peer lending matches up people seeking loans with people willing to give them. However instead of offering movie tickets and t-shirts, the lender sees their original investment paid back and then some. Because of this peer to peer lending is mutually beneficial for the lender and the borrower.
For the lender the loan is an investment. Each loan is paid back at a certain interest level which is calculated based on the borrower’s credit. If the borrower has weak credit the loan is deemed riskier, but the lender will make more money in interest when the loan is paid off. That being said, the rates that most peer to peer lending sites offer are below the average rate the borrower would pay if they left the balance on a credit card or took out a loan from a traditional bank.
Peer to Peer Loan Rates
So just how good are these rates? Lending Club -the largest peer to peer lending site — offers a rate table based on the borrowers credit and the length of the loan. A top borrower in the “A1” grade level can get a loan for as little as 6.03%. These grade levels go up to “G5” with an interest rate starting at 26.06%.
However not all of that interest goes directly to lender. Lending Club and other peer to peer lending sites charge an origination fee. These percentages are also broken down by grade with a 1% fee taken from “A” grade loans and a 5% fee taken from “G” grade ones.
For borrowers this is lower than most credit cards as Bankrate.com reports that the average fixed rate interest on credit cards is currently 13.02%. For investors, peer to peer lending is less volatile than other investments and offers consistency to their returns.
Types of Loans
A personal loan can serve many different functions, the most common of which is paying down credit card balances. Since many consumers hold multiple credit cards, it’s common for them to refinance and consolidate this debt by taking out a personal loan. This way they can pay off their high-interest credit cards and make a single monthly payment instead.
Other popular uses for personal loans include home remodeling projects, moving costs, vacations, medical expenses, car repairs, and more.
As the name implies, business loans are used to facilitate the starting up or expanding of a business. Given the current size of the loans most peer to peer lending sites offer (less than $100,000), these loans are typically associated with small businesses. However, Lending Club recently announced plans to increase their limit to $300,000. This could dramatically increase the number of business interested in peer to peer loans.
Like personal loans, business loans can also cover a wide range of uses. Some of these include opening a new location, remodeling an existing space, emergency repairs, or working capital to help with day-to-day operations.
Student loans are offered to those seeking higher education to help pay for expenses associated with that endeavor. Traditionally student loans are taken out as the borrower begins their schooling and only paid back after they’ve graduated or dropped out. This twist of not having to make payments or worry about interest accruing until after graduation has kept many peer to peer lenders away from these traditional students loans so far. Instead, many of the “student loans” offered on peer to peer lending sites are actually personal loans that can be used to pay the semester’s tuition in a lump sum, but the payments still begin immediately after the loan is given.
Real Estate Loans
A real estate loan is used to purchase commercial or personal property. Since these purchases cost far more money than the other loans mentioned, most peer to peer lending sites have not ventured into offering them just yet. However, sites such as Realty Mogul have sprung up offering crowdfunding for commercial real estate so it is possible others will follow suit in the future.
The Rising Market and Rising Regulations
Because of the benefits being seen for investors and borrowers, the market for peer to peer lending is growing. Recently, Economist.com reported that Lending Club and Prosper — who make up a combined 98% of the peer to peer lending market — gave out $2.4 billion in loans last year.
In 2008, a year after Lending Club launched, the Security and Exchange Commission took notice of the rise in peer to peer lending and decided to take action. As a result, every loan Lending Club or Prosper writes is now registered with the SEC and the companies send their financial reports to the commission as well. In fact, as Lending Club is set to make an initial public offering this year, Reuters reports that “going public will actually reduce Lending Club’s regulatory burden, by putting the whole company under the aegis of federal regulators.”
Is it Safe?
Along with this success has come some worry: What if one of these sites were to implode? After all, since peer to peer investments are not backed by the government, they are also not insured. So is investing in peer to peer lending safe?
The official site of The NASDAQ Stock Exchange recently set out to answer this very question. They cited confidence in Lending Club from investors such as Google and concluded that peer to peer lending “can be a great addition to your investment portfolio if you diversify your investments and practice the same good judgment you would when making any other important business decision.”
Just like any other investment, there is some inherent risk involved with peer to peer lending. However the advantages for both the lenders and borrowers have been proven over the last seven years as Lending Club has doubled the amount of loans they write every year. On top of that, Lending Club reports that 100% of investors with 800 notes or more saw positive returns with 93% seeing returns between 6% and 18%.
While crowdfunding may have given us a smart watch and the Veronica Mars movie, peer to peer lending has given customer sand investors a better way to save and make money on loans.