Peer-to-peer lending platforms have brought a shift in how consumers and investors save and deposit their money and how borrowers get loans from lenders. However, is this new financing technology safer than traditional banks and financial institutions? Please read on to find out more about the platforms.
What is Peer-to-Peer Lending?
Peer-to-peer (P2P) lending is a form of financial technology where an individual can get a loan directly from another individual or business without involving any intermediary such as a financial institution or a bank. On the contrary, both parties use a peer-to-peer lending platform to complete the transactions. Therefore, peer-to-peer lending allows borrowing and lending of money without engaging third parties.
The lenders in P2P lending usually consider the P2P lending platforms because of a better return on their savings compared to other traditional methods of financing. The lenders, on the other hand, are seeking a better alternative with lower interest rates than the banks and financial institutions.
Peer-to-peer lending is a concept that was birthed in 2005, but the competition in the lending platforms cannot go unnoticed. The shift from traditional methods of financing has seen a great number of people adopt the use of peer-to-peer lending platforms.
So, how do the platforms work?
Peer-to-Peer Lending Platforms; How Do They Work?
Borrowers and lenders using this new financing technology consider the lending platforms a better option than traditional banks and financial institutions. The platforms link up the two parties directly; lenders with borrowers and vice versa. They are like online marketplaces bringing borrowers and lenders together. Investing in a peer-to-peer lending platform allows lenders to make extra income on their money. On the other hand, the platforms allow a borrower, an individual, or a business, to get funding without going to a bank or any other traditional form of financing.
Notably, these platforms facilitate transactions. They also have the responsibility of setting the interest rates charged and the terms of borrowing and lending. While some peer-to-peer lending platforms allow lenders to choose who to give their money to, others automatically share the money among a bunch of borrowers.
Importantly, a borrower’s creditworthiness plays a huge role in determining the number of rates the platform will charge him. This, therefore, means that the rates vary from one loan application to the next. Importantly, having good documentation of credit records can help. A borrower with good credit records can bag lower rates compared to one whose credit records are sketchy. Furthermore, peer-to-peer lending platforms charge higher interest rates compared to traditional savings accounts.
Moreover, peer-to-peer lending platforms also charge fees and commissions. This can apply to the lender or the borrower, and at times, both of them. The fees charged may be similar to that of a traditional bank.
Importantly, some peer-to-peer lending platforms are specific. They specialize in certain borrowers. For instance, a P2P lending platform can strictly deal with small businesses while another one can be purely designed for linking doctors to potential patients.
Peer-to-Peer Lending in Crypto
With the introduction of cryptocurrencies, the money market has continued to change and evolve. Currently, blockchain and Ethereum have opened up their networks to their users to enable borrowers and lenders to interact. This process can be completed with the help of a third-party institution like a crypto bank or through a trustless agreement between the lender and the borrower.
As it would be in a traditional bank, the amount of crypto one can borrow is always depended on the collateral assigned. This method is mostly used since in such processes it is hard to evaluate creditworthiness or past history without identity in the decentralized network.
How to Invest in a Peer-to-peer Lending Platform
As earlier mentioned, investors in P2P platforms can make extra income on their cash compared to if they opted for traditional banks and financial institutions. So, how do you invest? The easiest way is to open an account with a lending platform. After having an account, you can pay some money either as a direct cash transfer or by debit card. Remember, it links you up with the borrower.
The next step is setting the interest rates. You can set it on your own or go for the ones offered by the lending platform. It depends on the terms of the P2P lending platform. Therefore, with an account, you can start giving loans to the borrowers for a fixed period e.g 2-4 years. Most platforms allow you to choose a borrower profile, hence determining the degree of returns you want; high or low risk.
The second way of investing in a peer-to-peer lending platform is to buy a stock, especially when the P2P platform is a public company.
P2P lending is riskier to the lenders. This is because unlike traditional banks and financial institutions which assume most of the risks, peer-to-peer lending platforms do not. The investor bears the weight. The following are some of the risks;
If you want to be a lender in a P2P lending platform, keep in mind that the individual or business you lend money to (the borrower) may fail to pay it back. This is termed defaulting, and the cases are most common in P2P lending platforms than in traditional banks and lending institutions.
Therefore, before investing in a P2P platform, ensure you check the default rate. The higher it is the greater the number of borrowers who are unable to repay the loans.
Late or Early Repayment
When giving the loan, you no doubt set a repayment period. However, with peer-to-peer platforms, the borrower may repay either earlier or later than you agreed upon. This can interfere with the profit expectations you had. The upside of early repayment is that you can lend someone else the money again.
P2P Lending Platform Going Out of Business
This is not surprising as there are reported cases of lenders who have lost their money as a result of P2P platforms going out of business. Therefore, ensure you invest in a platform that is regulated by the appropriate authorities so that you can have your money back whether it is in business or not.
Are You Ready?
Peer-to-peer lending platforms connect lenders and borrowers directly without involving intermediaries. They set the terms, fees, and charges and handle the transfer transactions. The good thing is that investing in one is not a tedious process. However, unlike traditional banks and lending institutions, this new form of financing is subject to several risks. For instance, peer-to-peer lending platforms are more prone to defaults. At times, the platforms may go out of business. Therefore, as an investor, dig deeper into a P2P platform before opening an account.
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