Peer-to-peer (P2P) lending isn’t really anything new. But it isn’t that old either. It took a serious hold in the mid 2000s and has enjoyed increasing popularity ever since. Now it’s experiencing another serious bump in attention as institutional investors start adding P2P loans to their portfolios. But what exactly is P2P lending? Who participates? Why is it “taking the internet by storm”? These questions and more are explored below.
What Is Peer-to-Peer Lending Anyway?
In the simplest terms, P2P lending is way for individual lenders to loan money to individual borrowers at interest. It sounds a little like a bank, but it’s different in many ways. It also sounds a little like a loan shark, but fortunately, it’s also not quite the same as that either.
P2P lending distinguishes itself from a bank in a few notable ways. The first way is that the loans are totally unsecured. This means that borrowers don’t put anything up as collateral on the loan. If they default, the borrow sits twiddling his/her thumbs. There is no car or house or personal property to posses; the lender exits with whatever interest was paid and nothing else.
Next, interest rates for lenders are much higher than if they simply parked their funds in a savings account. In theory a bank would use money from a savings account to conduct a similar service as peer-to-peer lending, loan capital to a borrower at interest, but the lender in this case has absolutely no control over to whom his/her money is being lent, and the return on investment (ROI), though guaranteed, is paltry at best.
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The list goes on, but the take home message is this: while interest rates are good for both the lender and the borrower, the lender accepts a rather sizable risk by entering into this kind of agreement, but can reap substantial rewards.
A few companies like Advantage Capital Funds at http://www.advantagecapitalfunds.com have taken this strategy and applied a slight tweak. They, like P2P lenders, lend money directly to the lender with no middleman or high bank fees.
It doesn’t require a great logical leap to understand that the typical investor (or lender) in peer-to-peer lending is someone who is comfortable with risk but willing to take a chance in order to make some serious money (the average interest payment on a P2P loan is 10%).
But who are the borrowers? The borrowers, so far, are typically consumers who have gotten into a little hot water with credit card debt and are looking for a cheaper way to pay off their remaining balance. P2P lending works for them by having investors buy their debt and switch the consumer’s monthly payment to them. The consumer generally pays a smaller interest rate than if they were dealing with a credit card company or a bank. Thus, a potential win-win for lenders and borrowers.
Taking the Internet by Storm?
It’s true. Since its inception P2P lending has taken the Internet by storm. At first only a few individual investors were interested in the system, but recently institutional investors have taken notice and have blown up the industry, nearly doubling the amount of P2P loan money available for certain lenders. And with ROI averaging 6-10%, it doesn’t appear to be going anywhere anytime soon.