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peer-to-peer lending definition

P2P lending, otherwise known as peer-to-peer lending, is a system that connects lenders and borrowers by eliminating middlemen like banks. This type of lending is mainly done online, and those sites that facilitate it have significantly increased in number as most individuals and businesses adopt it as a way to get financing.

The first peer-to-peer lending platform, known as prosper, was established in 2005. Since then, thousands of P2P lending sites have sprouted up across the globe.

How does P2P work?

P2P lending sites work by connecting investors to borrowers. It is the site that sets the interest rates and terms of the loans (however, there are those sites that give lenders the power to determine rates). It is important to note that you will notice different rates on loans within a single site. This is brought about by a difference in the risk associated with the loan and even the loan term.

The p2p lending process begins with the opening of an account on a site like Mintos. After successfully registering, the investor then deposits some money in the account which is used to invest in the different loans available. Peer-to-peer lending sites have different minimum amounts that an investor can invest, be sure of the minimum amount you require to invest before you deposit funds.

On the other side, a loan applicant submits their loan request to the lending site. The application is evaluated by a team of experts in the p2p site before it is published on the site. The P2P site also assigns the interest rate and categorizes the loan into a risk category, depending on the rating process followed by the site.

It is essential to point out that the investment process can be automatically carried out with the help of an auto-invest tool.

Benefits of investing in peer-to-peer lending sites

Before you make any investment decision, it is always important to have an understanding of the benefits that you are going to enjoy from your choice. By investing in P2P lending sites, these are the benefits that you will enjoy.

  • Higher rate of returns

Peer-to-peer lending sites have higher returns compared to conventional banking systems. Generally, the rate of return on the most platform is about 13%. The P2P sites can achieve such rates or yields because they have lower overhead costs, and set the interest rates on their own.

  • Regular source of income

Several peer-to-peer lending sites make monthly payments to investors. This ensures that you have a steady source of income every other month until the loan term ends.

  • It requires a small capital to start

P2P lending sites only need a small amount for one to invest in the loans published on their sites. Some sites allow investments of as low as 5 euros. With an investment of around 1000 euros, you can easily diversify your portfolio to tens of investment loans.

  • It is easy and fast to invest or borrow

Investors and borrowers can easily register accounts with the lending sites and transact within the dame day. This is not the case with banks where there is a lot of paperwork and bottleneck requirements that make it almost impossible to get a loan.

Nonetheless, peer-to-peer lending sites also have some disadvantages that are worth noting.

  1. Credit risk- the loans offered on P2P sites are usually exposed to high credit risks. A good number of borrowers for funding from peer-to-peer sites are those that have poor credit scores and cannot get financing from banks and other regulated financial bodies.
  2. No regulation– not all peer-to-peer lending sites are regulated by the government. As a result, if a site scams the investors, it would be nearly impossible to track it and recover the investor’s assets.

What risks are associated with P2P lending sites?

  • Money drag

Upon the completion of a loan term, investors reinvest their money into other loans on the platforms they are using. To make the reinvesting cycle more effective, an investor should use the auto-invest tool which automatically invests into other investments once a loan is paid off.

A money drag risk occurs when a loan that you had invested in finishes its term, and when payments are made, the money is left uninvested. The funds will be lying in your account without getting any returns.

  • Borrower default

When lending out money, there is always the risk that the person receiving the money may fail to pay. A borrower can default before you receive the entire loan back. Some platforms will help you recover such money, but the risk of losing the money is still there.

  • Loan originator bankruptcy

It is important to note that some peer-to-peer lending platforms offer loans that have been funded by other lenders while some vet and fund the loans themselves. If your site works with external loan originators, then you are prone to the risk of such originators going bankrupt. Some loan originators may even decide to default payments which will force you to take legal action to get your money back.

  • Platform bankruptcy

This is one of the most serious risks that are associated with peer-to-peer lending sites. Unlike the loan originator bankruptcy where your P2P team can help you recover the money, a platform bankruptcy is most likely going to lead to a loss of all your investments. However, there are some P2P sites like Bulkestate that separate their accounts with those holding investor’s funds, so that in the case the platform goes bankrupt, the investors’ money is still safe.

Conclusion

Thousands of businesses and individuals have benefited from the crowdfunding sites. Crowdlending remains to be a great source of finance for project developers, companies and individuals while ensuring that investors get a hassle-free income from the money that they lend.

It is advisable to always carry out thorough research about a given peer-to-peer lending site before investing in it. Understanding a P2P site is the first step in making a god investment decision. You can go through the reviews on different P2P sites, that we have compiled for you to understand how each P2P site operates.

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