Most of us have experienced the process of getting a loan from a bank or a financial institution – the arduous task of filling out forms, providing a plethora of information, and waiting for days, not to mention the many physical trips involved to the bank branch during working hours.
Now imagine an alternate scenario – one where you fill out a few pieces of information online, all from the comfort of your living room couch, and within hours have your loan approved. This dream scenario is now a reality brought about by a fast growing segment of online marketplace lenders offering platforms that match borrowers directly with lenders. This phenomenon is called peer-to-peer (P2P) lending. It is also known by various other names such as marketplace lending, alternative lending, social lending and crowdfunding. P2P lending is gaining traction and expanding rapidly to new product categories because it offers an improved experience and passes on the benefits of using technology to borrowers and lenders.
PwC’s analysis indicates the P2P lending market could reach $150 billion or higher by 2025
How P2P Lending Works?
Peer-to-peer lending works on a simple model, people sign up to the platform as either a borrower or a lender. The borrower submits an application for a loan. The lending platform leverages technology and online data to quickly assess risk, figure out a credit rating and assign an appropriate interest rate. This whole process is completed within hours or even minutes. Now the loan is available for investors to fund. Investors can be individuals, private companies or financial institutions and typically invest in many different loans to spread their risk.
Why is it So Popular?
P2P lending has emerged as one of the hottest industries in FinTech with a fast growth track and billions of dollars generated in loans every year. So why is it that P2P lending is catching on in so many different markets globally? We break down the reasons:
Benefits for Borrowers
- Low Interest Rates – The major benefit of P2P lending for borrowers is the low interest rates when compared to banks and credit cards. In some cases, where borrowers refinanced or consolidated existing debt through P2P lending platforms, they reported a reduction of as much as 35% on their interest rates.
- Fixed Rates – Fixed interest rates, even in case of a late payment, makes this a very attractive option, especially when compared to a credit card.
- Simple and fast application – The whole process is quick, painless and quite simple to understand and track. There is transparency, ease and options built into it. It offers customers the same digital experience that they have gotten used to in other areas of life, hence explaining the rapid growth.
- Low fees – P2P loans have lower fees when compared to other options. Moreover, typically there isn’t a penalty if you wish to prepay your loan, making it an attractive prospect for many borrowers.
Benefits for Lenders
- Higher returns – P2P lending offers higher returns to investors on average. Depending on the risk you choose to take, the returns could be either high or moderate. Most investors choose a combination of high risk and low risk investments.
- Diversification – It offers investors a chance to diversify their overall portfolio as investing in consumer credit is a completely different asset class than any other investment.
- Simple to understand – For individual investors, P2P lending is far easier to understand than most other investments such as bonds or stock trading.
- Opportunity to do good – A lot of investors are drawn to this form of lending as it gives them a chance to help others, small businesses or struggling families, who may not get help from traditional financial institutions. Some people also like the fact that real people and not a faceless institution is being helped.
Flip Side of the Coin
While there are tremendous advantages of peer-to-peer lending and growth has been breakneck, to create a balanced view, we consider some questions:
1. Do the investors fully understand the risks? P2P lending marketplaces are platforms – the risk of the loan is on the lender. Therefore, it is important to assess the credit rating process of a platform before you sign up as an investor.
2. Is it too young? The industry is still nascent and while default rates have been lower than the credit card industry, the timeframe is not large enough to reach a definitive conclusion.
The meteoric rise of P2P lending looks set to continue in the near future. In the long term, there are several factors that will determine the pace of growth including regulation in different markets, how the banks respond to this competition, and the overall shape of the global economy as determined by interest rates and employment figures.