I’m all about Peer to Peer lending and borrowing. For those of you who are unfamiliar, here’s a quick primer. Lots of people have trouble getting loans due to poor credit or lack of credit history. The loans they have access to may have extremely high interest rates and other usurious terms, so these people are left in the dust without access to money they need. This is a bigger social issue than you might think. The thing about wealth is that it tends to build upon itself, but for many people, it is earned through the careful management of an original risk. For many people, a loan will be the first major financial risk they take in life. But without access to a loan with anything resembling reasonable terms, they’re never able to put themselves on the road to wealth and upward mobility. Enter P2P.
Peer to Peer Lending and Borrowing grew out of capabilities that the internet gave us. These lenders could be decentralized, not reliant on brick and mortar institutions and their deep benches of shareholders. These websites (Prosper and Lending Club, most notably in the US) emerged to connect individual lenders (regular people with extra money) to individual borrowers (regular people who need money). Rates were set, terms agreed upon, and millions of loans were set up in this way.
P2P lending has had an interesting life (and several deaths) in this still-new millennium. While it was instituted to make traditional lending institutions (banks, fast cash rip-off places) unnecessary, it’s still largely unknown as a viable option in most markets. P2P has been most popular in Europe and North America, but the nation that has really cultivated a healthy P2P industry is England. Companies like ZOPA and ThinCats have become multi-billion pound lenders, with extremely low default rates, transparent practices, and a lot of happy users.
The Checkered Past and Reliable Present of American P2P
North America hasn’t been so lucky. Quite a few early P2P players (who shall remain nameless) fell by the wayside in the past five years. Others were corrupted, getting infiltrated by financing from the very institutions they were meant to supplant. The aforementioned Lending Club and Prosper are the only two well-known P2P lender/borrowers who still abide by the original tenets they used to establish their companies in the late 90’s. Headlines have espoused the death of American P2P for several years now – so why would I recommend that new users mess with these lenders at all?
Because they still work. Especially for lenders. For those unfamiliar, lenders get to look at a bunch of potential loans in an open market, then “bid” on those loans using a “reverse auction” style format, wherein the person offering the loan at the lowest interest rate gets to supply the loan. American P2P has had to regulate this process somewhat, fixing interest rates to credit scores in many cases, meaning that borrowers don’t get the full benefit of a field of lenders bidding down the cost of interest. But for lenders, this means that borrowers will be on the hook for more interest than they used to be when this format was new.
In general, I recommend that investors check out P2P Lending because the loans are usually very reliable. Of course, there are more defaults for higher risk clients, but the bar is actually pretty high for American P2P Lenders (Lending Club only accepts borrowers with a 640 credit score or above). Borrowers who are securing loans for things like mortgages almost never default, and annual returns for multiple loans often exceed 10%, depending on your risk tolerance. For borrowers, I would recommend American P2P only if your credit is stellar (this is the only way to secure awesome rates) and you need a loan fast.
The nature of North American finance has made it difficult for P2P to survive as its founders intended. But there are a group of intrepid entrepreneurs who continue to carry the torch. I hope to see a new generation of companies adopt the P2P ethos who are able to provide loans to a wider variety of borrowers than those presently served. The financial landscape will evolve (this much is certain) but to have the Peer to Peer ethos driving this change could be one of the most equitable of all possible financing scenarios.
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