What are peer to peer loans and how do they work?

There is a way of receiving loans called peer-to-peer lending or peer loans. The top peer-to-peer lender in the UK is ZOPA which first launched in 2005, introducing an accepted alternative to more traditional loans and investment options.

Over the last six years there has been a huge increase in outstanding peer loans. There is no middleman to help those who are looking to borrow money with those who have want to invest money. When the global economic crisis hit, peer loans started to increase massively. This occurred because people were finding it very difficult to get credit from banks and more traditional money lenders.

The reasons for getting a peer loan vary. Some people would like to pay for education, pay off their mortgage, pay vet bills, holidays, weddings etc. The most popular loan is debt consolidation. One of the main reasons why people look for peer loans is because of the better interest rates that are available. The lenders also benefit because they get a better return on their investment than they would if they had savings in the bank or other investments.

So how do they work?

  • The borrower choose how much they would like to borrow, state what it is for and then post a loan listing.
  • Investors then review the loan listings and if the criteria they are looking for is met then they will invest.
  • Once the process has been completed, borrowers make monthly payments to their investors and this is enforced by a promissory note.

These benefits are due to disintermediation, the low overheads compared to the more traditional financial institutions that have many employees and expensive locations. The lack of administrative procedures with peer loans has the added benefit that the loan application time and the transfer of the money takes much less time so both the borrowers and the lenders can get to their money much more quickly.

As peer loan companies and their client base keep growing though, the expenses involved are increasing. Administration and marketing expenses, developing websites which will stand out from competitors and draw in customers as well as having to comply with legal regulations means it has become more complicated. This means that peer loan companies are becoming more like banks.

Peer to peer lending may also attract borrowers who, due to their poor credit status or lack of any credit status at all would not fulfil the criteria to borrow from the bank or building society. Peer loans help such people avoid the perils of loan sharks or predatory lending, which have extortionate interest rates. Although it must be noted that for those with very low credit scores some peer to peer loan companies have begun to turn these potential borrowers away.

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