5 min read7 June 2019
Peer to peer lending, or p2p lending, is an alternative method of securing funding without the help of traditional financial institutions. Here's everything you need to know.7 June 2019
Peer to peer lending (often referred to as p2p lending), or peer lending, is a type of alternative business funding of securing funding without the help of traditional financial institutions. Peer to peer loans work through online services matching borrowers with lenders, helping eliminate additional costs with significantly lower overhead. Companies have been using peer to peer platforms to help fund projects at more attractive rates since around 2005.
With peer to peer lending, lenders (also known as investors) have the opportunity to secure higher rates of return through interest, when compared to the traditional saving models offered by a bank. For those looking to borrow money, peer to peer platforms promise fast and simple applications, often paired with lower rates than the high street lenders. Most peer to peer platforms will offer services for investors and borrowers to ensure the transaction works best for all, including security features that enable borrowers to match safely with lenders, identity verification processes, credit checks and marketing tools to help identify new lenders and borrowers.
In terms of size, most peer to peer loans fall into the same category as small business loans. For example, many P2P sites offer loans of between £5,000 and £500,000.
Peer to peer borrowing is faster and often cheaper
By using a peer to peer (p2p) lender, the connection between lender (or investor) and borrower is much closer, especially when compared to a bank. Helping individuals or small businesses obtain loans directly from others helps cut out the middle-man – banks or other high-street lenders – and typically eliminates several criteria that can slow the process down. This explains why peer to peer lending has surged in popularity in recent years. In fact, approximately £12bn has been invested through 23 major services since 2005.
Borrowers are credit checked
Peer to peer investors want to know where their money is going. So, borrowers on a peer to peer platform are credit checked by a credit reference agency before being qualified to request a loan. This check is what’s known as a ‘soft check’ and doesn’t affect the potential borrowers credit score. In fact, many peer to peer lending platforms run in-house credit and eligibility tests on borrowers, while others help investors filter through different scores to help identify riskier (high return) or safer (low return) borrowers.
When it comes to repayments, peer to peer loans could be competitive
Peer to peer loans have gained popularity over recent years due to their low-interest rates. Depending on credit and financial history, borrowers can usually benefit from competitive repayment rates from a peer to peer lending provider. Typically, P2P loans are advertised with rates of around 3%.
Investments may be split into separate chunks
To cut the risk of losing a loan after a borrower is unable to repay, several peer to peer outlets split the lenders' investment into separate pieces, which are individually handed out to borrowers.
There are different kinds of peer to peer lending platforms
When it comes to peer to peer lending, it’s not a one-size-fits-all approach. Different outlets are designed to help different situations and when borrowers can range from individuals to small businesses, different factors come into play. Some peer to peer sites specialise in certain types of lending.
Peer to peer providers connect borrowers directly with investors. Each peer to peer platform or website offers different interest rates that work in-tandem with the borrower’s individual credit score.
For investors, a lender account is opened and a sum of money is deposited as an individual loan – some peer to peer platforms offer the opportunity for this to be divided into smaller chunks for safer investing across multiple offers. For the borrower, the peer to peer platform assigns the user a risk category, which then dictates how much interest is paid back through the loan. Sometimes investors can ‘haggle’ with potential borrowers, or the process can be fully automated.
This flow chart shows the movement of funds from individual lenders, through a P2P platform and to the borrowing business, as well as tracking the repayment of funds.
Firstly, as most peer to peer platforms are online, the application process can be considerably quicker than traditional methods, with many offering a turnaround over just a few hours. Secondly, as investors are being matched with borrowers through an online platform, there is no need for additional overhead costs that often slow down the process.
Things are kept simple, too. While a borrower’s loan is provided by an investor, the lending platform acts as an intermediary party between the borrower and the lender. Often, both parties are kept anonymous from each other and there can be very little contact between the two. Peer to peer loans, generally, are more flexible than other methods, helping you dictate what day of the month you make repayments as well as offering the chance to make an overpayment or to settle the balance of the loan early.
While some banks and building societies vary in charging a fee for a loan, most peer to peer platforms will charge an arrangement fee.
The fee mainly goes towards two things – keeping the p2p platform in business and contributing to security measures to protect investors from a defaulted loan, when a borrower can’t pay the money back. Generally, the total fee amount will depend on how much money is being requested.
Before securing funds, potential borrowers will also be subject to a credit check. Every peer to peer loan (p2p loan) will require a borrower to pass a credit check before additional checks done by the individual company. If you have a history of poor credit, it may be more difficult to get peer lending.
Peer to peer lending and crowdfunding are quite similar methods of funding. Both involve individuals investing into a project or a business, alongside being alternative methods of gaining funding.
However, peer to peer lending and crowdfunding can be quite different. Here’s why:
Crowdfunding, firstly, is often used as a word to generalise funding which can come from the public. Reward-based crowdfunding and equity crowdfunding are two, more specific, examples, using rewards – such as a gift from backing a Kickstarter project, for example – or providing a stake in equity after a successful round of funding. The risk with crowdfunding, however, is that the investor may lose their original investment completely if the project fails. For the business seeking funds, it’s clear to see the advantages. Generally, crowdfunding lends itself well to those with high knowledge in a subject, as well as hosting a closer relationship between the two parties.
Peer to peer lending, however, rewards its investors by paying a percentage in interest back. It’s a significantly less risky method of investing, too – especially when compared to crowdfunding – as it makes more reliable returns. Peer to peer lending comes with its own risks, but is usually a safer option than making a punt on a new company’s shares.
All of these options mean it’s important for you to gain a firm understanding of what funding method will work best for your business. Be sure to take time to explore other options, such as iwoca’s business loan, before making a decision. Check out our business loans page to see what's on offer.
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