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Peer-To-Peer Lending: An Introduction For Independent Minds

Alternatives to the dominant banking systems of the world are few and far between.  If you’re trying to break free of the shackles of debt, get capital for a new business venture, or find a way to grow your wealth, it can be hard to navigate the system in a way that doesn’t make you feel like you are financing the worst of the capitalist world.  Still, for those willing to look outside traditional boxes and take control, there is hope in the form of emerging peer-to-peer lending networks.

What is Peer-to-Peer Lending?

Peer-to-peer lending is a way for individuals to lend money to others at a profit in a way that divides the risk of lending among a group.  In this sense, it is different than lending money to your brother-in-law and charging him interest, because that scenario leaves you with all of the risk.  Peer-to-peer lending takes the total amount needed by an individual borrower and allows multiple people to lend a small portion of the total to fund the loan.  The payments made by the borrower are then divided out to all of the lenders in proportion with the amount they put into the loan.

Most peer-to-peer lending systems work through a centralized platform.  The dominant for-profit platforms in the United States are Prosper.com and LendingClub.com.  Both have been in operation for a little over three years.  They make their money by taking one percent of the interest on the loan as their transaction fee, with the rest of the interest on the loan going to the individuals who funded the loan.

Who Can Use Peer-to-Peer Lending?

Peer-to-peer lending networks can be used by prospective borrowers and potential loan investors alike.  The main requirement is registration, which asks for basic personal information and requires you to select a username.  Depending on your state of residence, you may need to complete additional online forms.  Some states don’t currently allow peer-to-peer lending, but each platform maintains an expanding list of where they can do loans.

For borrowers interested in getting a loan, many of the same standards as traditional lending apply.  You will be asked about your income levels, outstanding debts, homeownership, and employment status, and receive a recommended interest rate based on this data.  Unlike traditional loans, you also have the chance to write up small statements that tell potential lenders why you want the loan, what makes you a good candidate for the loan, and what’s behind any spots of bad credit or delinquencies.

For potential lenders, you simply need to register and transfer money into the platform.  From there, you can look through borrowers’ listings, read their statements, and decide how much money – if any – you want to put into a given loan.  The smallest allowed investment is $25, with the upper limit the maximum needed to fund the loan fully.  Average returns range from 4% to more than 25% depending on the risk level of the loan.

What Kinds of Loans Are Available?

The loans available through peer-to-peer lending platforms are considered personal unsecured loans, just like credit card debt.  You do not have to put up collateral to get a loan.  The most commonly sought loans are for debt consolidation, home improvement, medical or moving expenses, and business capital.

Loan terms are flexible, in that borrowers can select a loan term that gives them between twelve months and five years to pay back the loan.  Investors and borrowers alike seem to favor the three-year term, as these are the dominant type of loans that are funded on peer-to-peer lending platforms.

What’s the Catch?

For investors, you are investing in people, not guaranteed securities.  Borrowers may be late with payments or even default on their loans.  The lending platforms have collection agencies that will work for you for a share of the funds recovered, but the risk of loss is important to remember as you make investments in people you don’t know personally.

On the borrowers’ side, the main catch is the limited amount of capital available.  Loan levels are capped at $25,000 on Prosper.com and $35,000 through LendingClub.com, though you can borrow much less.  Also, whether or not you get your money depends entirely on a jury of your peers, who do not know you personally and may choose not to lend you money.  Borrowers with fair to good credit histories generally do better than “high risk” borrowers.

Closing Thoughts

Though peer-to-peer lending isn’t perfect, it is an alternative to traditional banking or credit card companies.  Interest on loans flows to individuals, not institutions, and loans made help real people manage their debts or launch new businesses.  Whether you are looking for a new way to find funding or looking for a new way to invest, peer-to-peer lending could be just what you seek.

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