Peer-to-peer lending—or P2P lending, for short—is a new kind of crowdfinance that is shaking up the banking world. Think about how a bank makes money: they take in deposits and pay a miserly interest rate to depositors, then they lend the money out (through loans or credit cards) at much higher rates. P2P web sites do an end run around banks by allowing individuals to lend directly to other individuals (and sometimes businesses). By cutting out the middleman, borrowers can get lower rates and investors can make higher returns. In fact, many people use P2P sites such as Lending Club and Prosper to refinance their expensive credit card debt.
Borrowing requests are graded by risk level, with interest rates ranging from 6% to 25% or more. After losses and fees, average investor returns hover around 9%. Investors cannot see identifying information about the borrower, but they can see the location, so P2P lending can be a way to invest locally. That said, diversification is prudent in P2P lending.
While P2P lending started out as people lending to other people, the investors these days are likely to be hedge funds, institutional investors, wealthy individuals and even banks. For that reason, the term peer-to-peer has been replaced by “marketplace lending” as the preferred description. Nonetheless, individuals can and do participate, and marketplace lending is helping thousands of Americans lower their costs of borrowing and earn higher returns on their money.
- Very good returns
- You help others reduce their borrowing costs
- Fairly anonymous transactions
- You can screen by location if you want to lend in a specific area, but that may increase geographic risk
- Lending platforms typically take a 1% fee on payments to investors