Why do people use P2P lending?

3A new generation values personal freedom and wants to take control of their work and leisure. They believe in people, not banks and rather than work for one company for 30 years, they prefer to collaborate in networks on various projects for short periods of time. The spread of web technologies, which foster mass collaboration, is creating a variety of new tools. These tools enable individuals to work together online in huge groups to achieve mutual goals. At the same time, the disintermediation is everywhere. Technological change, globalization and other international trends continue to reduce the number, size and role of business intermediates in many industry sectors. This led to development of micro and peer-to-peer lending.

P2P lending, also known as “social lending”, lets individuals lend money directly to other individuals and businesses. Just as eBay removes the middleman between buyers and sellers, P2P lending companies like Zopa and Prosper eliminate financial intermediaries like banks and credit unions. Why did it become a popular alternative?

The major benefits of P2P lending are:

  1. Better deal. Lenders can get returns that are several percentage points above those for a bank CD; Borrowers enjoy cost advantages compared with rates at a bank or credit union.
  2. Choice. Many individuals like knowing who they’re lending money to and why they need the money. It gives them a sense of personal satisfaction, as well as a choice – who they believe will repay the loan in full and on time.
  3. Emotional connection. If a potential borrower has a dodgy financial history but a sympathetic story to tell, a lender can choose to forgo a higher return and/or assume greater risk to fund the loan.
  4. Community. There can be a true sense of community at a P2P lender site: active forums and information exchange about lending and borrowing experiences.
  5. Bankophobia. Some people just hate banks and will do anything to avoid using them.

The downside of P2P loans:

  1. Credit score. Many borrowers are excluded because they do not have good credit score.
  2. Fraud. Lenders face exposure from defaults, and their funds are usually not insured – the success of P2P lenders to limit loan losses varies by lender and over time. Plus, a lender can be lulled into making a bad loan by a good emotional sob story.
  3. The process. Compared with just walking into a bank or credit union, P2P lending can demand a lot of work, especially if the loans are funded through auction. The loan selection and bidding process can demand a level of financial sophistication many people don’t have.
  4. Privacy. Not everyone wants their financial story published on the internet so for those with some sense of personal privacy, the impersonal big bank has its charms.
  5. Formation process. Because this is such a new industry, there is bound to be waves of lender consolidation, administrative changes and changes to the lending practices. This may be more of a burden and risk than disciplined investors are willing to allow.

P2P financing is booming. Existing platforms all operate in different ways, and the sites that lend money to businesses tend to offer higher rates than those lending to other individuals. Some, such as Zopa and RateSetter, are at the mainstream end of the sector, while others are more niche or high-end. Some consolidate the funds, and some allow lenders to make a choice. Given new approaches emerging, everyone can find a mechanism that fits them the most.