Everyone can lend money to individuals or businesses, without an official financial institution participating as an intermediary in the deal, by using online platforms that match lenders with potential borrowers. This practice is called social lending or peer to peer lending and is gaining traction and seems certain to become more popular. There are social lenders in several countries, including Italy, the Netherlands, China, and Japan, with startup operations in many other countries.
Social lending offers both secured and unsecured loans. However, most of the loans in P2P lending are unsecured personal loans. Secured loans are rare for the industry and are usually backed by luxury goods. Due to some unique characteristics, social lending is considered as an alternative source of financing. P2P lending carries a load of benefits and risks with it. Let’s see now which are the benefits and the risks.
Benefits of social lending
Social lending has many benefits for the everyone who uses these p2p platforms. Here are 5 of the most crucial benefits that might convince you into going for this lending mechanism.
- Easy application. There are necessary only a few pieces of personal information and the approval process is very fast.
- Higher returns. Lenders can earn higher returns compared to savings and investment products offered by banks.
- Lower interest rates. Borrowers can borrow money at lower interest rates, even after the P2P lending company has taken a fee for providing the match-making platform and credit checking the borrower.
- Speed of funding. Funding typically takes just a few days so the borrowers can have the money very fast.
- Spreading risk. The majority of loans are filled in much smaller $25 or $50 by any lender, so lenders can diversify by borrowing a big number of borrowers at the same time.
Risks of social lending
Social lending has many risks for the lenders. Here are 3 of the most crucial risk that everyone needs to know before going for this lending mechanism.
- Risk of default. P2P loans are exposed to high credit risks. Many borrowers who apply for P2P loans possess low credit ratings that do not allow them to obtain a conventional loan from a bank. Therefore, a lender should be aware of the default probability of his/her counterparty.
- No insurance/government protection. The government does not provide insurance or any form of protection to the lenders in case of the borrower’s default.
- Legislation. Some jurisdictions do not allow peer-to-peer lending or require the companies that provide such services to comply with investment regulations. Therefore, peer-to-peer lending may not be available to some borrowers or lenders.
Social lending has many benefits but also many risks, especially for who decide to borrow money using these online platforms. Who decide to use the social lending platform needs to be very carefully, because there is the risk to lose part or all the invested money.