What is peer-to-peer lending and how does it work?
In this guide, we're going to look at what peer-to-peer lending (P2P) is and how peer-to-peer lending works for borrowers and lenders. We'll also take a look at what the future of P2P lending will be.
What is peer-to-peer lending?
Peer-to-peer lending platforms bring together people looking to invest money with prospective borrowers who are looking for a loan. They perform the role of an intermediary, assisting in the matching of two parties and the transfer of money between them. Because there's no traditional financial institution acting as a middleman, and therefore none of the overheads associated with banking, the lenders and borrowers could both benefit from more favourable interest rates.
P2P lending can be an attractive option to those who are looking to boost their investment portfolio and are ready to take a small amount of risk to do so. With interest rates on savings and cash ISAs currently struggling to beat inflation, investing is could enable you to protect the value of your money, and P2P lending can be less volatile and less complex than investing in stocks and shares. You can find out more about the advantages of peer-to-peer lending in our guide.
How does peer-to-peer lending work?
For the lender
The peer-to-peer lending process begins when you sign up to a P2P platform and invest the amount you wish lend. You will then need to begin making lending offers to borrowers looking for a loan. Before your offer is made you need to decide how long you wish to offer your money for, which is usually over a fixed period of years. As a rule of thumb, the longer you're willing to invest your money for, the higher the potential returns.
Once your money has been transferred to your peer-to-peer account, there are typically two ways to start lending it out: some P2P platforms will automatically make lending offers to borrowers that match your loan terms on your behalf, while others will require you to do it manually. While individually managing each loan gives you the most control, it can be more time-consuming — doing it automatically speeds up the process and ensures your money is always invested.
Once you've been matched with a borrower (or multiple borrowers) and the loan has been disbursed, you'll begin to earn interest. Depending on your platform, you'll be presented with management options for what you want to do with your earnings. The best platforms will offer an automatic re-lending service, where the repayments in your account are automatically offered for lending once again, maximising your returns.
There will often be an option allowing you to draw a regular income from your repayments, usually on a weekly or monthly basis. You may also get a choice over whether you want to withdraw the full repayments or just the interest you've accrued. This can usually be set up automatically, or with the option to manage your earnings completely manually - again giving you full control, but at the cost of time and convenience.
For the borrower
Should you be looking to borrow through peer-to-peer lending, the process begins when you apply to a P2P platform for a loan. Most companies will require you to fill out a quote request and provide some proof of identity, then they will carry out a credit check to gauge your credit history.
Based on the results of the check, you'll be quoted a provisional APR, as well as a breakdown of your prospective loan that includes important details like the amount, duration, monthly cost and total amount payable. You'll then be able to carry on with the rest of your application.
At this point, your completed application will be assessed by an underwriter who will make the final decision on whether you're accepted. A more in-depth credit check may be carried out and you will need to meet the platform's own creditworthiness checks too. If you're approved, you'll then be made a loan offer and matched with a lender (or multiple lenders) who is willing to provide funds that match your quoted criteria. You can then choose to accept or decline the offer.
Though the loan amount will be coming from lending 'peers', the platform will act as an intermediary and you won't be dealing directly with any other parties. Once the loan has been paid, you will make regular repayments through the platform, which will pass them onto the lenders.
What is the future of P2P lending?
Since its establishment in the mid-noughties, peer-to-peer lending has seen nothing but growth, and that trend looks set to continue. A report by the Cambridge Centre for Alternative Finance charted a 43% growth in the UK's alternative finance in 2016, with the P2P consumer lending market worth around £1.17 billion, up from £909 million in 2015.
There are quite a few reasons for the success of P2P lending: banks and building societies' inability to offer favourable rates to savers, people looking for more opportunities to diversify their investments, and increasing confidence in online financial services and peer-to-peer networks. And, with just 7% of people having used a peer-to-peer lending service, according to an EY survey published in the Financial Times, it seems that the sector is nowhere near reaching its full potential.
It’s worth remembering that P2P lending is a relatively young industry that hasn't been exposed to the full stress test that other lending institutions have been subject to over the decades. However, while new risks, like rising interest rates and regulatory pressures, may prove to be tough challenges that need to be overcome, the future for peer-to-peer lending looks very bright indeed.
Getting into peer-to-peer lending with Lending Works
Here at Lending Works, we provide an established and reliable peer-to-peer platform for lenders and borrowers alike. Thanks to our innovative options, you can manage your finances and loans easily and make sure that your money is always going to the right place.
For savers, we can provide an investment opportunity that beats traditional savings accounts with rates of up to 5.4% p.a. and an exceptional level of protection from risk with our Lending Works Shield. Borrowers can get a quote in less than two minutes and access loans at a rate of 9.9% APR representative, with easy and convenient repayment options. It is important that we highlight that with any peer-to-peer lending platform, your capital is at risk.