The internet has caused changes in many areas of society, and the consumer credit market is no different. Whereas in the past the market was dominated by the big financial institutions such as banks, building societies and the like, the World Wide Web has enabled the rise of networks of peer to peer lenders.
What are Peer to Peer Lenders?
While most lenders are financial institutions or other companies operating as money lenders, peer to peer lenders are different: they are private individuals that come together to lend to other private individuals or in some cases businesses. They do this by offering money for people to borrow on peer to peer lending sites, websites which are set up to act as portals for those wishing to offer peer to peer loans. The purpose of these sites is to bring lenders together with potential borrowers, with any lending supervised by an intermediary: sometimes this intermediary is the organisation backing the peer to peer lending website, but this is not always the case.
The function of the intermediary is to provide a mechanism for the peer lending to take place, and to provide services that enable the credit worthiness of the borrower to be assessed, either by a full or partial analysis of the borrower’s credit rating, or by another mechanism devised by the intermediary. This latter service is very important as most p2p lending involves the provision of unsecured loans, meaning that if the borrower defaults on the loan there is no collateral the lender could sell to recoup some money. For their services, these intermediaries are paid a fee; this is usually a charge added to any loan that is arranged and processed fully. The total amount of loan charges gained by providing a service is usually enough for an intermediary to be profitable; as a result, more intermediaries are becoming available.
Once the intermediary has performed their duties, then lenders can offer loans. Taking the borrower’s credit rating as a baseline, the rate of the loan is set either by the intermediary making a judgement based on its internal processes, or by lenders bidding to offer loans, with the lowest rate being offered to the borrower. With the latter, it is important that the winning bids are not too low; otherwise the loan will not be profitable. It is important to note that more than one lender could supply the funds for the loan: it is not uncommon for many peer to peer lenders to each supply a small part of any given loan. The borrower will see no evidence of this, however, as part of the intermediary’s job is to handle this and present the loan as a single package.
Why Become a Peer to Peer Lender?
The main reason for those with spare money to invest to become peer to peer lenders is the return they can get on their investment. The returns possible from offering person to person loans – if a mutually beneficial deal can be struck between lender and borrower – are generally better than a similar investment in high interest bank accounts, ISAs, bonds or the like.
Another reason people might get involved in p2p lending is a desire to provide affordable loans to consumers or businesses that might not normally have access to them: with the contraction of the credit market, many consumers and companies have been finding it difficult to access funds due to traditional lenders becoming more risk averse. Peer to peer online lenders help provide an alternative, and help people avoid taking on debt from lenders that charge very high interest to those that find it difficult to get credit, such as payday loan companies, doorstep lenders, pawnbrokers and loan sharks.