How Does Peer to Peer Lending Work?
Peer to peer (P2P) lending operates in two stages. Each P2P business loan provider will assess your application up front and will either approve or decline the application, much like a bank. They will run checks to ensure the loan meets their criteria and is seen as a reasonable proposition to offer to their investors.
These assessments will take place through the completion of an application form, and by requesting copies of your accounts and business bank statements.
Once your loan is approved, it is usually put onto an online platform, which displays the details to their registered investors. The investors will all then assess the loan from a personal perspective to decide whether they feel the loan is a suitable risk for them personally. If it is, they will then pledge an amount of money that they feel comfortable lending.
If enough investors are willing to commit funds, then you will eventually hit the figure that you’re looking to borrow, and the loan can be issued to you.
Why Has P2P Lending Become So Popular?
Peer to peer lending has been used widely in the unsecured business loan sector and is providing major advantages for both borrowers and lenders. If the loan is repaid without issue, it’s a positive outcome for everybody.
P2P business loans are generally more flexible than traditional bank funding and businesses are finding them easier to secure. Where funding is limited from banks, the new wave of P2P lenders are willing to take a view on a businesses prospects and how the cash injection could help them.
Applications tend to complete much quicker than traditional bank loans which is another plus for businesses. When company owners want to borrow money, they usually want to know that their loan will be agreed as quickly as possible so that they can access their funds rapidly.
Peer to peer loans are also much more convenient to arrange. There is no need to take time out to visit a branch or wait for your account manager to come back to you. Most applications are submitted via online platforms and a lot of the underwriting is done upfront, giving you an almost instant indication of your chances of success.
Peer To Peer Lending vs. Bank Loans
Traditional bank loans are funded through the lender’s balance sheet. Savers put their money into the bank for a pre-agreed interest rate and the bank will look to profit from that money while they hold it. Chances are, they will lend it out to a person or business.
Those funds are never strictly earmarked as yours and, if the borrower defaults, it is the bank’s problem, not yours.
Banks will usually be committed to long-term debt that they are locked into, meaning that they are reliant on borrowers keeping the same amount of money with them, on average. These deposits and loans never really come to light in the public eye, unless savers withdraw their money en masse, as happened during the demise of Northern Rock.
The interest paid to savers is usually much lower than the interest received from borrowers, but of course, there is no risk of loss to the saver.
With P2P lending, the outcome for the borrower is the same, they apply for a loan and receive a lump sum, which is repaid through one monthly payment. The real difference takes place before the money is loaned to you.
Instead of going through a traditional lender, the loan is funded by individuals who pool their money together to provide the business with its loan. This changes the landscape for the saver significantly, as they are no longer just taking a small cut of the interest charged, they take it all.
Cutting the bank out in this way does come at a cost. If the borrower defaults, the losses belong to the individuals and are not absorbed by the bank.
This means two things to the individuals who invest in your loan – higher risk and higher rewards.