Originally posted on https://bonsaifinance.com/peer-funding-peer-peer-lending-work-lc/
Peer funding is an innovative way of lending and borrowing money. By 2050, this method of lending is expected to have a value of around a trillion dollars a year.
It’s big news, but what is the peer to peer industry all about?
The big clue is in the name. Peer funding means lending to, and borrowing from, your peers.
By your ‘peers’ we just mean other people. It’s not as informal as borrowing twenty bucks from your brother though. We’ll explain all in a moment.
One of its key benefits is that there’s no need for banks to get involved. This means better results for people who are lending and borrowing cash.
If you want more details about peer to peer lending, carry on reading. We’re going to talk you through each step of the peer funding journey in all its detail.
How Lending Works in Principle
For those of you who have never borrowed money before, let’s start with the basics of borrowing.
No problem if you already know what’s up, feel free to skip to the next section.
Borrowing From the Bank
When you borrow money from your bank, it gives you the money as a cash sum.
Over time, you’ll pay that money back. This is usually in the form of monthly payments – meaning that it’s a type of installment loan.
Except you’ll pay more cash back to the bank than you borrowed in the first place. This will happen because your bank charges a ‘rate of interest’ on the loan. This is shown as a percentage when you take out the loan.
The rate can vary a lot depending on your creditworthiness and the bank you’re working with.
Some loans are called ‘secured’ loans, meaning that there’s some form of collateral attached. For example, if you take out a car loan, the car itself may be the collateral. If you didn’t keep up to date with your payments, the bank would take (repossess) the car from you.
Missing a payment is called ‘defaulting’ on the loan.
With unsecured loans, as there’s nothing except the money for the bank to take back. That definitely doesn’t mean there’s no need to pay the money back, but there’s less risk involved for you.
But it’s how the banks make their money. So what’s the deal with peer to peer lending?
Peer to Peer Lending
Peer funding is pretty similar to borrowing from the bank. However, you’re borrowing money from your peers rather than a bank.
You’re still assigned a rate of interest on your loan. You’ll also have to keep up with your monthly payments until the loan is paid off.
So what’s the point in peer funding, we hear you ask? If it’s more or less the same as normal lending, why even bother? Well, here’s why.
Peer Funding Can Often Give You a Better Deal
When borrowing money, some people can take advantages of great rates through peer to peer lenders.
To check current rates, visit a peer to peer platform (a website) to see what they’ll quote you for the amount you want to borrow.
The rates of interest on offer are normally much better than the ones available on bank loans. Though it’s always worth checking those before you make a decision. It could be a surprise.
However, in most cases, you’re likely to save a hefty chunk of cash by taking out your loan via peer funding routes.
This is why peer funding platforms are said to be ‘disrupting‘ the loans marketplace. Banks have massive costs they have to cover to keep their enormous businesses running.
In many cases, they would struggle to meet, let alone beat, peer to peer rates.
What Impact Can Borrowing Have?
Borrowing money via a peer funding platform will leave a mark on your credit report, just like every other time you borrow money.
What’s a Credit Report?
A credit report is a record of your financial accounts, including any loans you’ve taken out in the past. That includes any times you failed to make payments on a loan.
A new loan on your credit report isn’t necessarily a bad thing, and future lenders probably won’t be too bothered by it. Unless there’s a lot of requests for credit in a short space of time, they probably won’t think twice.
There’s one exception, where you should take care with your requests. This is if you’re planning to take out a mortgage in the near future. Mortgage lenders will be more bothered about your financial history than a loan provider.
Lots of requests for credit, even if they’re spread out over a longer period of time, might make them think twice about your mortgage request.
Great Rates or High Stakes?
If you can benefit from better rates than traditional lenders will offer, then good for you. Peer funding loans can save you a lot of money, as they cut out the middleman (the bank).
To be clear, the platform does still take a cut of what’s being repaid, but what it takes is generally far less than a bank.
But there is some evidence that peer to peer lending isn’t all that helpful for everyone.
For example, one study found that certain groups of borrowers using peer funding experienced negative results. Specifically, a 47% increase in their credit card balances after taking out peer to peer loans.
Chances are high that this is the same group of people who are struggling with their daily finances, to have to take out so much credit.
This means that some people who take out these loans are just getting themselves into more debt. Plus, they’re leaving black marks all over their credit report. So perhaps peer to peer is not always the answer – at least not for everybody.
Lending on Peer to Peer Sites
Peer to peer lending has become very popular in some investment circles. Especially among smaller investors who don’t have the resources to spend loads of money trading stocks.
This is largely because you can get a much better rate out of lending your money on a peer to peer platform than you can with a traditional savings account.
With a savings account, you pay in money and for a set amount of time, you’re delivered a certain rate
However, peer funding is not for everyone. There are risks involved in this type of lending, and it’s not always a good option.
For example, you might find the flexibility of a credit card very helpful. It could be much more beneficial in your circumstances than borrowing a thousand dollars all at once through a peer to peer website.
Is My Money Safe?
Peer funding platforms take measures to make the process less risky. But they can’t eliminate all of the risks.
Firstly, they’ll ‘diversify’ your money for you. This means that rather paying in $1,000 and it all being lent to one person, they might assign $100 chunks of your money into ten separate loans.
This means if one person has difficulty paying, you don’t lose all your cash.
Having said that, if several of the people you’re lending money to stop paying their loans, part of what you lent might get written off.
Some providers set aside pools of money for this reason. When people default on their loans, the pool makes up for losses. However, if a very high number of defaults came through, the pool might not have enough cash.
It is possible to lose money when lending to other people via peer funding.
Rates can Fluctuate
Lending through peer funding comes with the risk of fluctuating rates. When you lend your money, the platform will set a ‘target’ rate that it hopes to achieve for you. Unlike a regular savings account, this is far from a guaranteed rate.
Peer to peer platforms offer borrowing rates which differ depending on who’s requesting. If loads of people with great credit request, they’ll lend all money in the pot out at low rates.
In turn, you’ll get less money back than you might’ve hoped. This can be very disappointing, and you may even find you’d have been better off with a savings account.
Likewise, if particularly diligent borrowers pay their loans back faster than expected, they’ll pay less interest for the loan. This will also have a negative effect on your investment return.
A large volume of defaults on the borrowing side of the business can also impact the actual rate you get.
How Fast is Peer Funding?
That’s a difficult question. It depends firstly on whether you’re a borrower or a lender.
But the speed of receiving a loan decision, or having your money lent out to borrowers, varies greatly too. It depends on which platform you choose to use, and how efficient it is.
Let’s look at the speed of both sides of the peer funding equation in more detail.
Borrowers: Requesting a Loan
Sometimes it’s at least quite easy to tell whether your request will be accepted or not. This is thanks to online tools provided by peer to peer platforms.
However, the actual request process can be a little sticky. The platform might run a credit check on you, and if it turns up any flags, this can delay the process.
If you have some blemishes on your credit record, you may also find that the rate you’re offered isn’t so competitive after all.
And if the platform comes back to you to carry out more checks or to ask for identity verification? You could wait for days to receive your loan money.
Lenders: Queuing for Investment
When you pay money into a peer funding platform, you have not lent your money out. Not at this point, anyway.
Your money is put into a holding account.
It waits there until the queue of money ahead of it has all been lent out, and is then assigned to new loans.
Sometimes, it can take weeks for the money to reach borrowers. And while it’s sitting in the holding account, you’re not making any money.
The same thing happens when your investment returns come through. The money sits in the holding account until a suitable loan is ready for it to be used.
However, the reinvestment is given priority over new money on most peer funding platforms.
That’s great news if you’ve got lots of money on the platform already which is performing well. It’s not that useful if you’re a new investor who wants to put a fair amount of money into these loans.
You might have to wait for a while before it starts to work properly and deliver any return on investment.
I Need a Fast Loan Right Now!
Not able to take advantage of preferred rates on peer to peer platforms, due to a poor credit record? Don’t think that you can put enough trust in the arrangement?
That’s OK. Peer funding doesn’t suit everybody’s needs. It doesn’t have to be your final choice, and there are plenty of other options out there if you need to secure credit in a hurry.
Bonsai Finance doesn’t just help customers secure fast loans and credit cards. We want to help you improve your financial situation in the long-term.
If you have a patchy credit history, don’t worry. Our friendly team is not judgmental in the slightest. In fact, we’re very keen on offering you friendly advice on how to deal with your credit history and find a route out of debt.
If you’d rather go down a more traditional route, request your loan now via our simple online form. We’ll get back to you quickly with details of what we can offer you, and how we’ll help shape your finances for the future.