If you need money fast to get out of debt, finance a home improvement project or make a big-ticket purchase, getting a loan can be a good option. The most common type of loan is a personal loan that is funded by a bank or credit union. However, peer-to-peer lending is becoming more popular, and in some cases, it might be a better option than a personal loan.
How does peer-to-peer lending work?
Peer-to-peer lending is an alternative to taking out a traditional loan. Most of these types of loans come in the form of personal loans, and the borrower can use them for a number of reasons, including home improvement, debt consolidation or as a small business loan. With peer-to-peer lending, you are not borrowing from a bank. People decide whether they want to invest in your loan. That’s the peer-to-peer part.
Most peer-to-peer loans are given by online websites. Borrowers can go to various websites looking for a loan and hoping for a better interest rate than what they would get at a bank. Peer-to-peer loans are a way for the potential borrower to get rid of the middle man and deal directly with a lender.
The whole application process takes place online and usually has a short turnaround time. If enough investors bid to invest in your loan, the bank will offer you the loan and you could potentially get your money in as little as a few days. The bank then sells the loan to an investment company that securitizes it into debt held by the peer investors.
Popular peer-to-peer lenders include Lending Club and Prosper. Regardless of where you decide to get a loan, you’re looking to minimize its interest rate and fees. The peer-to-peer lenders will let you know the interest rate on the loan with a soft credit pull, which does not negatively impact your credit score.
The interest rate will depend in large part on your credit history. On its website, Prosper states annual percentage rates by Prosper Rating range from 5.99% to 36% for first-time borrowers. “The average APR for borrowers during 2019 was around 13.9%,” it says.
Types of peer-to-peer loans
One reason why peer-to-peer loans are valuable is because you can access the same types of loans that you could through a bank, at a lower cost. Peer-to-peer lenders most commonly provide personal loans that can cover almost anything, including debt consolidation, credit card balances, home improvement and more. Another perk is that peer-to-peer loans generally have more favorable and flexible terms than a bank would offer.
If you need money for something specific, most peer-to-peer lenders also offer auto, business, student, mortgage and even medical loans. Many people are turning to peer-to-peer lenders to borrow money for high-value purchases or expenses because they are unsecured. That means that if you have a peer-to-peer auto loan and you become unable to make the monthly payments, the lender can’t legally seize your car as collateral.
Regardless of the type of loan you apply for, keep in mind that your credit score will still dictate your rate, and determine whether or not you get approved. However, some peer-to-peer lenders argue that it’s more lenient on credit scores than a bank would be.
It’s important to shop around with both banks and peer-to-peer lenders to get several different quotes to find one that will give you the best rate.
Benefits and drawbacks of peer-to-peer lending
The main benefit of peer-to-peer lending is that applicants can usually get a lower rate than they could through a traditional lender. And when you’re going to be making monthly payments over several years, securing a low rate you can comfortably afford is a major incentive. If you need money quickly, the application and approval process with a peer-to-peer lender is sometimes much faster than going through a bank.
But on the other hand, there are several drawbacks to peer-to-peer lending. For one, the applicant still has to pass a credit check in order to get approved. Peer-to-peer loans are far from guaranteed, so they shouldn’t be viewed as a last resort. Remember that the lower your credit score, the higher your rate will be.
Additionally, because peer-to-peer loans are unsecured, it means you’ll get sent to collections if you can’t repay the debt. Most bank loans are secured, which means you are required to put down collateral, such as a vehicle, if you are unable to make your payments. So while losing your car would be a major headache, not paying an unsecured loan can quickly put you in deep debt or even bankruptcy due to the high interest rates on unsecured loans.
Peer-to-peer lending vs. bank loans
The primary difference between a bank loan and a peer-to-peer loan is who will grant the loan to the borrower. If the money comes from a lender who is an individual or a group on a web-based platform, then it’s a peer-to-peer loan. If the money comes from a credit union, bank or another financial institution then it’s a bank loan.
Bank loans often come in the form of a personal loan. Customers who are in good standing and have good credit may benefit from a bank loan because of the competitive interest rates. The typical interest rates in comparing a peer-to-peer loan to a bank loan are very similar. A peer-to-peer loan ranges from 7% to 39% APR, whereas a bank loan ranges from 6% to 36% APR.
The bottom line
Overall, a peer-to-peer loan is similar to a traditional bank loan, with several main differences. Peer-to-peer loans have looser eligibility requirements, quick turn-around time for approval, and you may be able to get good terms if you have good credit. Even if you have less than excellent credit, you may still be able to get a loan. With a bank loan, you get the stability of borrowing from a well-known institution and your rates and terms may be a bit lower, especially if you have good credit.
Some people will benefit more from peer-to-peer loans, and for others, getting a traditional loan from a bank is a better option. Before applying, get quotes from multiple different lenders and see where you can get the best rate.