Peer to peer lending ( or p2p lending as its commonly referred to) has been picking up steam lately and I have had a few emails from readers asking about what exactly is peer to peer lending and is it really all that useful after I posted about lending club.  Well here is a quick rundown of what peer to peer lending is and how peer to peer lending works.

Lets start with a definition (from wikipedia):

Peer to Peer lending

Peer-to-peer lending is a means by which borrowers and lenders may transact business without the traditional intermediaries, such as banks. It can also be known as Social Lending. The ripple monetary system is a software project based on a similar idea. An enabling technology for peer-to-peer lending has been the Internet, where peer-to-peer lending appears in two primary variations: an “online marketplace” model and a “family and friend” model.

The marketplace model of peer-to-peer lending on the internet enables peer lenders to locate peer borrowers and vice-versa. This model connects borrowers with lenders through an auction-like process in which the lender willing to provide the lowest interest rate “wins” the borrower’s loan. The marketplace process may include other intermediaries who package and resell the loans but the loans are ultimately sold to individuals or pools of individuals.

The “family and friend” model forgoes the auction-like process entirely and concentrates on borrowers and lenders who already know each other, as with two friends or business colleagues formalizing a personal loan. Whereas the primary benefit of the marketplace model is the “match making” aspect, the family and friend model emphasizes online collaboration, loan formalization and servicing.

Sounds interesting, does peer to peer lending work?

I have tried out a couple of the places, most notably lending club that I was using extensively and actually had a full review written up about that I ultimately had to throw away because they are now semi defunct. In my experiences with both Lending Club and Prosper (another one of the most well known sites) it has worked very well. On the lending side, lending is fairly easy and straightforward. You can have money transferred in from your bank and be ready to go in a couple days.  Default rates are a bit higher than regular lending, but a lot of this is because you can get a loan on (at least Prosper) with basically completely wrecked credit.  Whether or not anyone funds you is a whole different story.  There ARE collections agencies that are used so even on default there are odds of recouping your money.

On the borrowing side it is a little more involved but still fairly no hassle. You give out information and people decide if they want to fund your loan or not based upon the information you’ve provided and on your credit history. I never actually took out a loan but had one up to test it out.  People are generally trusting and I found it fairly non stressful to put a loan up.

Do you recommend peer to peer lending?

I actually really like the idea of cutting out the middle man: the bank.  Sure whoever is administrating things is going to make some money as a middle man but the returns are better for investors and generally the loans are reasonable for people with good credit.  There are also a lot of situations where bank’s will not make loans when it makes sense (some business ventures for example) and I find that p2p lenders are more open to lending to businesses, albeit at a higher rate.

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