Peer-to-peer (P2P) lending or social lending is essentially debt crowdfunding. P2P platforms bypass banks by connecting online lenders with borrowers for mostly small loans — like credit card debt — using proprietary technology to assess risk, creditworthiness and interest rates.
Savers decide the amount they want to invest and the platform, or sometimes the lender himself, diversifies the investment among several borrowers with different profiles, in order to mitigate the risk. The borrowers, instead, create their profile by uploading the necessary information and indicating why they need the loan, for example for purchasing a car or paying a wedding.
Borrowers then pay periodic interests as determined by the platform depending on their default risk and creditworthiness. Generally, the rates for borrowers are lower than the ones offered by banks, because P2P platforms operate with a lower overhead and thus they are able to provide the service at a cheaper cost. At the same time, lenders receive, on average, higher interest rates than with banks. This because the investment through P2P platforms is de facto riskier than investing through banks, which often ask for collaterals to protect the investment from the default risk.
P2P platforms are for profit organization and they apply a small fee on both investors and borrowers.
Is P2P lending for you?
P2P lending is mostly used for personal projects, like purchasing a car, and many platforms do not lend to businesses. However there are P2P platforms that are specializing in business lending to small and medium enterprises. If you have a web startup and you are considering to finance your company through debt, you will probably have difficulties to find a loan with favorable lending conditions even on P2P platforms. In fact, the risk level of a startup is quite high and this will cause the interest rate to grow. Unless you have collateral to secure your loan with, you may want to consider other type of crowdfunding first, like equity crowdfunding or reward crowdfunding.