Peer-to-peer (P2P) lending is a platform that allows both borrowers and lenders to cut out the middleman from their transactions.
Imagine a hybrid between crowdfunding and marketplace lending.
If you're not familiar with crowdfunding, it is when many investors pool together small amounts of money to finance a project or a startup.
The concept of P2P lending is pretty straightforward—on one hand you have people who want to borrow money at better rates than banks, and on the other you have people who want to lend their money to earn interest faster than a savings account ever could.
P2P lending platforms help match people from the two sides. By cutting out middle parties like banks and other financial institutions who tend to leach off on such transactions, you end up with a win-win for both borrower and lender.
The application process is typically pretty quick and painless too.
You'll know if you qualify within 24–48 hours.
Borrowers can secure a loan over the internet from individual investors, removing the need to rely on traditional financial institutions.
Investors benefit from the interest they earn on the loans they give out, while borrowers receive the funding they need cost-effectively and in a timely manner.
Prosper is a P2P business that is currently dominating the marketplace.
We're going to take a look at how it managed to fund almost 12 billion in loans using a lending platform that isn't even mainstream.
First, let's dive a little deeper into what goes behind the scenes of P2P lending.
We will cover some of its benefits and discuss why it can be so attractive to both lenders and borrowers.
Making The Best of a Bad Situation
The mistakes of major banks have paved the way for P2P lenders
P2P lending began to spring up as an industry after the financial crisis of 2008 when banks started to tighten their lending policies.
The banking crisis meant that potential borrowers were given far fewer options to choose from than in the past.
At the same time, low-interest rates impacted potential investors. This meant people couldn't earn the same rate of return they'd come to expect from their CD's or savings accounts.
P2P lending sites came about by seeking to fill this burgeoning gap in the market.
Several companies noticed the issues consumers were facing and launched online platforms to conveniently connect potential investors and borrowers with each other.
With the public's trust in banks at an all-time low, the concept of person-to-person lending really took off.
Since then, the peer-to-peer lending industry has grown in excess of $25 billion.
P2P loan categories differ depending on the service you use, but some of the major ones are:
- Home and auto
The amount borrowers can tap into varies from site to site as well.
Amounts range from as low as $1,000 for a personal loan to small business loans of $500,000.
Whether you want to borrow money or have a bit extra to invest, P2P lending sites have user-friendly layouts designed to guide you through the process of making an informed decision for yourself.
Check out the websites of the top P2P lending platforms (especially their FAQ sections) to quickly tell if a lender is the right fit for you.
P2P Lending Is a Win-Win
When banks are taken out of the equation, everyone comes out ahead
Borrowers get access to loan funds at attractive interest rates, while some even get funds that they otherwise wouldn't have been able to get elsewhere.
Lenders get a return on their investment which far exceeds what they could get from a savings account or CD, although not without an increased risk.
Two of the largest peer-to-peer lending platforms, Prosper and Lending Club, have originated more than $6 billion in loans to date.
Prosper, in particular, has taken what was then a newly launched business model and used it to become a thriving P2P lending platform.
Although the company was founded way back in 2005, it is still seeing impressive growth up to this day.
More About Prosper
Meet one of the pioneers of the peer-to-peer lending industry
Prosper offers what most P2P lenders do; it gets borrowers and lenders in contact with each other to facilitate the lending process.
Prosper's original vision was to create "an eBay for loans."
It wanted to help individuals in need money request it from individuals looking to invest.
From 2006–2009, Prosper used a variable rate model and acted like an eBay-style online loan auction marketplace.
It allowed lenders and borrowers to determine and agree upon the final loan rates.
As of 2010, Prosper changed its business model to use pre-set rates that it determined.
Rates are now determined using a formula that takes a borrower's credit risk and other factors into account.
Prosper is open to most US residents.
However, residents of the following three states are currently not permitted to borrow through the lending platform:
- North Dakota
As with most peer-to-peer lending sites, Prosper acts as an underwriter but doesn't loan out any actual money itself.
Instead, it matches potential investors with borrowers, and makes money by charging a fee for providing the service.
The loans you can get through Prosper are personal loans.
Borrowers generally have the freedom to use it for anything they want.
There's no need to pledge collateral against your loan amount; you get approved based on your income and credit rating alone.
Loans can be repaid over 3–5 years.
Borrowing from Prosper is typically less expensive than using credit cards.
This makes it an excellent solution for the consolidation of multiple debts that currently have a high combined interest rate.
When you borrow money through Prosper, you pay interest as you would with any other loan.
It also charges an origination fee which it refers to as a "closing fee."
All rates and fees are determined by your credit score, so the better your credit, the less you'll end up paying.
Prosper's minimum credit score requirement is 640.
Interest rates on the platform can range from 5.99% to 35.99% APR (annual percentage rate).
Your rate has fees included in it, but the majority of it is made up of interest.
Your closing fee will come out of your loan, so it's important to keep this in mind when figuring out the amount you need to borrow.
Closing fees start at just 0.50% if you have great credit, but can be as high as 4.95% if you have poor credit.
There are additional fees for missed payments, but no prepayment penalty, so you are free to pay your off debt as soon as you want.
Know what is required to make sure that you qualify for a P2P loan
Some borrowers will definitely have better luck getting approved for a loan through an online peer-to-peer lender.
Getting a loan through a big bank can be especially tricky if your credit rating is less than excellent.
You still need to meet specific criteria to get a loan through Prosper.
Prosper will check your credit through Experian to ensure you have a score of 640 or higher.
Borrowers with excellent credit are obviously preferred.
The average credit score of a Prosper borrower is a little over 700.
Investors will also carefully examine your debt-to-income ratio when deciding whether to lend to you.
This shows them how much of your monthly income you have available to repay loans.
Prosper generally looks for a debt-to-income ratio below 50% on new loans.
You need to have an income to borrow through Prosper, but it doesn't necessarily need to be employment income.
In fact, Prosper specifically states that retirees can borrow.
Self-employed people with proof of their earnings (such as tax returns) are able to borrow as well.
To qualify for Prosper, your credit report needs to be free of excessive inquiries or recent bankruptcies.
You'll also need to build up your credit before applying to Prosper, in case you've never borrowed before. This is sometimes referred to as having "thin credit."
If you've defaulted on a loan before, you're obviously unlikely to get approved.
Prosper's Borrowing Process
Gather all the information you'll need to provide before getting started
Your Prosper application requires basic information about yourself such as:
- Social security number
- Information about your income
Proof of income might be required in the form of tax returns or pay stubs, so be sure to report it accurately.
You'll need to provide Prosper with your bank account information as well, including account and routing numbers.
This way Prosper can transfer funds directly to your checking account as soon as the loan has been processed and approved.
The full process from applying to receiving funds in your account takes an average of about three days.
There were 4 Key Factors behind Prosper's explosive growth
Prosper's massive growth and success can be attributed to four key areas where it dominated the competition.
These have to do with the following lending criteria:
Let's take a closer look at how Prosper approached each of these areas to offer a solution that was unlike any other.
Prosper offers more attractive returns for an investor at a lower risk
For lenders and investors, peer-to-peer lending offers higher interest rates and returns than what banks can offer.
P2P investing is also highly diversified.
Savvy investors can achieve a lower level of risk than with traditional investments.
Prosper provides average returns in the 6–10% range.
Risky investments offer the possibility of earning more than 10%.
Prosper investors are typically earning more than what they would from traditional fixed-income investments. That's even if you take into account the fact that they're directly taking on the risk of loan defaults.
At this point you might be wondering if investing or borrowing through Prosper is as safe as using a traditional bank.
I would argue that they are actually quite comparable.
Loans originated by Prosper are made through WebBank, an FDIC regulated industrial bank.
It is subject to examination and potential regulatory investigations. Enforcement agencies still work to ensure legal compliance.
Prosper is a legitimate company with several million members on its online lending platform.
As long as your Internet connection is secure and you're on the actual Prosper.com website, applying for a loan is a safe process.
Of course, all online companies are at slight risk of a data breach, and Prosper is no exception.
And the very act of borrowing money always has associated risks as well, so be sure it makes sense to take on additional debt.
Consider how you'll be paying the debt back over time and whether there are any alternatives to help you make an informed decision.
The peer-to-peer lending industry has amped up its credibility
The peer-to-peer industry hasn't always been the most credible. It has suffered from security issues and heightened regulatory oversight in the past.
Prosper has been working hard to change that impression over the years and has made significant changes and improvements to beef up its own security.
Recently, institutional investors have started placing serious amounts of money into Prosper.
That includes one firm which has invested nearly $30 million and pledged another $120 million in the coming years.
Long-time Goldman Sachs executive Eric Schwartz joined the board of Prosper in 2012.
The following year, father-son team of Stephan and Aaron Vermut joined Prosper. They left the prime brokerage services division of Wells Fargo to join the company.
This meant that people could no longer write off P2P lending as just a fad or passing trend.
Goldman Sachs even announced that it would be the first bank to enter the P2P market in 2015, which they did so in that year.
It now offers both unsecured personal loans and also loans for small businesses.
All of these moves have helped to legitimize Prosper and the peer-to-peer lending industry as a whole.
Prosper found a way to capitalize on the rise in credit card debt
You might think that because you already have a line of credit, a car loan, or some other form of debt that you can't benefit from a P2P loan.
That isn't the case!
Online P2P lenders can be used to refinance your existing loans at a reduced interest rate.
This is one way to lower your monthly payment amount and take 5% or more off your total balance owing.
You can use P2P lending to consolidate high-interest debts you may have.
This gives you the opportunity to pay off your loan faster and improve your cash flow.
I think that making use of P2P lending is one of the best tools that the average consumer has at their disposal.
It can help reduce credit card debt and other high-interest amounts owing.
Outstanding credit card debt in America is at the highest point ever, at more than $1 trillion.
In fact, debt consolidation is the most common type of loan at Prosper.
About 65% of loans on the platform are for debt consolidation, mostly for paying off people's high-interest credit card debts.
Many people who feel overwhelmed by credit card debt are attempting to dig themselves out.
It can be tricky with interest rates that commonly climb up to 25% or higher if the borrower misses a payment.
Debt consolidation through a service like Prosper often proves to be a better option for debt repayment.
A borrower with a decent credit rating can get a 36-month P2P loan at 12%.
This can help pay off their high-interest credit cards, allowing the borrower to become free of credit card debt in three years or less.
It's a win-win for the borrower as well as the investors who loan the money.
Besides that, banks can be tight-fisted when it comes to debt consolidation loans or any loan for that matter.
P2P offers borrowers an option for unsecured loans at rates that are historically unprecedented.
Many borrowers can secure peer-to-peer loans with rates up to 5% lower than what's offered by their credit card.
As if that wasn't reason enough for borrowers to choose P2P companies over banks, most P2P loans are offered at a fixed rate.
The option to apply for a loan without having to complete pages of paperwork or go through a lengthy approval process certainly doesn't hurt either.
The bottom line is: people are looking for cheaper alternative forms of financing.
Peer-to-peer companies like Prosper give them that opportunity.
It made the loan application and approval process as simple as possible
From a borrower's perspective, the basic P2P lending process goes something like this:
You choose the P2P lending platform of your choice, and they do an initial soft credit pull to assess your initial eligibility.
P2P lenders may be an option available to those who can't get a loan through regular banks.
However, they still have relatively strict credit history criteria to ensure you'll be able to pay back what you borrow.
If your credit score is good enough to qualify, the lender then conducts a hard credit pull.
This is used to assign a "loan grade" to you, which helps investors consider how much of a risk it might be to lend to you.
Once you have been assigned a loan grade, you're able to make a listing for your loan.
This will include details such as the interest rate you're willing to pay.
You can also include an introduction and make a case as to why you need the loan.
The more creative and heartfelt the listing, the more likely you are to grab the trust and attention of a potential investor.
Investors are then free to bid on open listings by offering their own interest rates and the amount they'd be willing to lend.
One significant advantage of P2P lending for investors is that they don't need to put all their eggs in one basket.
There's no need for them to fulfill your entire loan and are free to spread out their risk by investing a few hundred dollars between many different borrowers.
Once your listing has ended, all of the qualifying bids from investors are combined into a single loan. It is then deposited into your bank account as a borrower.
It's an entirely different experience than what you'd receive from traditional banks.
Borrowers can apply for a loan with only a few pieces of information.
Requests can be approved within hours, which optimizes and improves the lending experience.
Once approved, loan funds can be deposited directly into your account in a few hours.
In the early days of Prosper, there was no loan management system.
Employees had to review each loan manually before approving it, which was a tedious and time-consuming process.
Now it has built a custom and upgraded solution. It's incorporated automation to manage all loan-related activities.
The entire process became a lot more streamlined.
Prosper's technology now facilitates billions in loans. It does this by making use of simplified application processes and quick lending decisions.
Peer-to-peer lending is an excellent alternative to high-interest forms of debt for borrowers
Prospect connects borrowers and investors directly. It cuts out banks and other intermediaries to the benefit of both parties.
Peer-to-peer lending is not yet a popular or mainstream method of acquiring credit. Yet Prosper has still managed to fund over $12 billion in loans.
Prosper loans are unsecured. However, they aren't significantly more risky than traditional investment options. They also typically come with a better rate of return for investors.
Prosper accomplished explosive growth. It did it by focusing on four things and doing them exceptionally well.
First, it combined more attractive rates with lower risk.
It also focused on, and took advantage of, the increasing credibility of the industry.
Prosper was savvy enough to capitalize on the rise of credit card debt.
Finally, it focused on making the loan approval process as easy as possible.
Have you used Prosper or another P2P lending solution? If so, feel free to share with us your experience in the comments section below!