Person to person loans
If you have ever borrowed or lent money to a friend, you will have an idea of what person to person lending is. It is an idea that ordinary people who have extra money they want to invest, can do so by giving loans to other people just as a bank would.
What separates peer to peer loans from the traditional way of lending to a friend is that in this case the lender and borrower are
strangers to one another. It is also done for profit whereas you wouldn't charge your friend interest on a loan.
How they work
Borrower account:
For the borrower, it works in a similar way to bank loans; you can go directly to the lending website, for example
Zopa, or through a broker.
After signing up for a borrower account, you apply for the loan and a credit check will be carried out. If you're considered credit-worthy,
you get a quote based on your credit score; the better your credit score the less interest you're likely to pay.
The money will be taken from one or several lenders and sent to your bank account. In most cases repayments will be taken directly from your current account, you can also manage your account online.
Lender account:
In order to lend, you needs to sign up a lender account which will be connected to your current account.
A lender doesn't need to have a lot of money to get started; you can lend as little as £10.
Once you've got the money into the account, you can decide the level of risk you want to lend at; the lending website will score each loan applicant, they will also explain the risk levels to you the lender.
If you decide to lend only to those with high credit scores, it is less risky but you will earn less interest, on the other hand, if you lend to low credit score applicants you stand to earn more interest but there's also more risk of bad debt.
Charity lending:
Lending also has a charitable aspect to it; on person to person lending website
Kiva, you lend your money to entrepreneurs,
mostly in developing countries, who want to start or expand a small business.
The entrepreneurs often have profiles on the website, through which they explain what they intend to do with the money
as well as update their lenders on how the business does.
Since Kiva lending is charitable, you only get back the money you lent out, there's no profit to be made.
Advantages
Cheaper loans:
For the borrower, peer to peer loans can be cheaper than bank loans; this is because the people who lend set their own interest rates,
if there is enough competition some lenders will lower their interest rate.
Online account management:
Both lender and borrower can manage their accounts online, some lending websites will even allow early repayments without fining the borrower.
Participate and make money:
Traditionally, only financial institutions have been able to loan money and charge an interest. With peer to peer loans, an ordinary person
can play that role and make themselves some money, the interest rate you earn is normally higher than what you get from a savings account.
Disadvantages
Not available to people with bad credit:
Applicants who have bad credit are unlikely to get a person to person loan as lending websites have so far opted to minimise the risk to their lenders.
You can experience bad debt just like the banks:
As you would be lending your money to other people, you are exposed to defaults or troubled repayments just as a bank would be
exposed to those risks. The lending website would have procedures in place to try and protect you from bad debt, however,
it is still possible to lose your money.