Peer-to-peer lending is just one piece of the greater sharing economy that has boomed in the past ten to fifteen years. In a nutshell, it allows regular non-institutional investors with just a few hundred dollars to fund loans for borrowers. It cuts out the bank or large credit institutions in the process, allowing borrowers to obtain more competitive interest rates, and giving individual investors another opportunity to diversify their overall investment portfolio. Peer-to-peer lending burst onto the scene in 2005 when Prosper launched the first major peer-to-peer lending platform. Since then, a number of peer-to-peer lending networks have come into prominence. In its latest iteration, companies such as USA Express Loans, a California licensed payday lender, are seeking to bring the peer-to-peer lending experience to the market for payday loans in California. They hope to better democratize the process, and offer interest rates far lower than traditionally available in the risky short-term lending space.
The Investor Experience
Investors with as little as $25 can begin funding loans in the peer-to-peer lending space. There is no licensing, training, or prior experience required for an individual investor. Many platforms provide comprehensive, albeit voluntary, training for new investors in order to help them understand their appetite for risk and to learn about different factors they can use in evaluating whether or not they would like to fund a loan.
Before listing any loan requisition to the public, most peer-to-peer networks complete an extensive underwriting process to determine the interest rate for the loan. Most platforms use a grading system between A – F, with a few different interest rates in each grading category. A-grade loans are the absolute lowest interest rate with the lowest likelihood of default, whilst F-grade loans are the highest interest rate with the highest likelihood of default. Investors seeking a higher ROI generally will fund D through F grade loans, while investors seeking a more stable ROI will fund the A through C grade loans.
When an investor accesses their dashboard, they are also able to see a number of key metrics related to a loan application, including the job title of the applicant, their debt-to-income (DTI) ratio, monthly income, and a number of different public records (bankruptcies, foreclosures, monetary judgements). Properly evaluating this data allows investors to further aggregate their choice of a loan to fund beyond the simple A to F grading system that the platforms use in their process.
The Borrower Experience
The borrower experience is seamless. As with any other online loan, lenders fill out a simple loan application that asks for information that is used during the underwriting process. Practically no loan goes unfunded through the peer-to-peer lending networks. Some networks require a borrower to wait until all investors have funded the loan before they disburse the funds, while other networks will carry the balance of the funds while investors are funding the loan. This second method allows the borrower to receive their funds quickly, while the individual investors have a week or more to fund behind the scenes.
Borrowers generally have access to
a portal in order to manage their loan. In this portal they can see information
such as account balance or their next payment date. They’re able to adjust
payment amounts or the date of a payment through these portals.
Your Overall Investment Portfolio
Peer-to-peer lending can make a great component of your overall investment portfolio. Investors on Lending Club are seeing returns between 5 to 15%. As with any investment, these returns can vary significantly depending on an individual’s appetite for risk, and their willingness to dedicate time towards tuning their portfolio.