What Is Peer-to-Peer (P2P) Lending?

Peer-to-peer (P2P) lending enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman. Websites that facilitate P2P lending have greatly increased their adoption as an alternative method of financing.

P2P lending is also known as “social lending” or “crowd lending.” It has only been around since 2005, but the crowd of competitors already includes Prosper, Lending Club, Upstart, and Funding Circle.

Understanding Peer-to-Peer Lending

P2P lending websites connect borrowers directly to lenders. Each website sets the rates and the terms and enables the transaction. Most sites have a wide range of interest rates based on the creditworthiness of the applicant. First, an investor opens an account with the site and deposits a sum of money to be dispersed in loans. The loan applicant posts a financial profile that is assigned a risk category that determines the interest rate the applicant will pay. The loan applicant can review offers and accept one. (Some applicants break up their requests into chunks and accept multiple offers.) The money transfer and the monthly payments are handled through the platform. The process can be entirely automated, or lenders and borrowers can choose to haggle.

Some sites specialize in particular types of borrowers. Funding Circle, for example, focuses on small businesses. And Lending Club has a “Patient Solutions” category that links doctors who offer financing programs with prospective patients.

History of Peer-to-Peer (P2P) Lending

Early on, the P2P lending system was seen as offering credit access to people who would be spurned by conventional institutions or a way to consolidate student loan debt at a more favorable interest rate.

In recent years, however, P2P lending sites have expanded their reach. Most now target consumers who want to pay off credit card debt at a lower interest rate. Home improvement loans and auto financing are also available at P2P lending sites.

The rates for applicants with good credit are often lower than comparable bank rates, while rates for applicants with sketchy credit records may go much higher. LendingTree.com, for example, listed personal loan rates from 6.40% to 36% as of Dec. 4, 2023. The average credit card interest rate was 21.19% as of Dec. 7, 2023, according to the Federal Reserve.

For lenders, P2P lending is a way to generate interest income on their cash at a rate that exceeds those offered by conventional savings accounts or certificates of deposit (CDs).

Special Considerations

People who wish to lend money through a P2P lending site need to consider the possibility that their borrowers will default on their loans, just as conventional banks do. Research on P2P lending platforms has indicated that defaults are much more common than those facing traditional financial institutions, sometimes in excess of 10%.

By comparison, the Federal Reserve's index of delinquency rates on all loans at all commercial banks shows that rates have fallen from about 3.76% to 1.32% over the ten years prior to Dec. 2023.

Any consumer or investor considering a P2P lending site should also check the transaction fees. Every site makes money differently, but fees and commissions may be charged to the lender, the borrower, or both. Like banks, the sites may charge loan origination fees, late fees, and bounced-payment fees.

The Bottom Line

Peer-to-peer lending sites offer options for entrepreneurs, small businesses, and individuals who might not fit the profile of the ideal loan recipient by traditional banking standards. While P2P lenders may extend credit more easily, it comes with higher fees and interest for borrowers and a higher risk of default for lenders. Many P2P platforms make it easy to invest or borrow, but read the fine print to learn about all the associated fees before signing anything.