Peer to Peer Lending (P2P), also known as Marketplace Lending (MPL) or Crowd Lending, was seemingly unstoppable until fairly recently. Despite early successes, some of the biggest players in the industry began imploding last year amid a number of crises. Lending Club, the largest P2P US operator, halved in May 2016 after a very public employee fraud scandal and the resignation of its top executive. Prosper, the second largest, suffered a bit of a PR disaster when it was found to have lent money to one of the San Bernardino shooters.
The crux of the issue, however, lies in the relative lack of oversight within the industry. Since these companies aren’t banks, they’re not subject to the same scrutiny as more traditional institutions. Loans are only summarily audited, despite SEC intervention, and the worries over the scant supervision has been reflected in the decrease in consumer trust (Lending Club went from an $8bn valuation in 2014 to less than $1.7bn today, despite lending 68% more in the first quarter of 2016 than it did the year before). Additionally, as most P2P make their money through processing fees (notably, our best in category SoFi doesn’t charge for origination) and have notoriously low expenses, they have little skin in the game and not much to lose if and when borrowers default on their loans.
The question is, can these platforms can acquire and maintain enough investors to be sustainable? More and more, they’ve been looking to institutions such as hedge funds to supply the capital for their loans, by repackaging loan portfolios as securities. Sound familiar? Maybe that’s because the subprime mortgage crisis of 2007-2009 largely consisted of the same situation, in which lenders funded high-risk mortgages by repackaging them into pools that were later sold to investors. If enough people borrowing money default on their payments due to some sort of generalized financial crisis, P2P companies may freefall into a similar collapse.
Lenders are most at risk, as there is no guarantee on their investment. Increased institutional involvement may eventually prove to be a double-edged sword, however, turning P2P into companies little different than the banks they originally set out to challenge. Although additional regulations may offer security to lenders, odds are interest rates will go up for borrowers, who would then have to jump through the same sorts of hoops they were attempting to bypass by appealing to a non-traditional platform.
The model works like this: P2P companies play the role of a financial cupid, matching investors with borrowers through originated loans (loans for X amount minus a processing, closing, or originating, fee). Some are similar to crowdfunding, in which you submit your application to a quality score and post it for 14 days, so potential investors can review. If you reach the goal or a percentage thereof, you can decide whether to go through with the loan or not. Other sites draw from a blind pool of investors, and the company itself chooses whether to approve your application or not, according to their own criteria. Generally speaking, most companies split up the investor’s money in smaller $25 amounts which are then distributed amongst a series of loans, in an attempt to reduce the risk on return.
There are three main types of P2P, although some companies have recently expanded into mortgages and auto loans:
Personal - These are given for a variety of reasons, from debt consolidation or extra cash, to an unexpected expense such as a funeral. They offer a lower amount than business loans and consider all the same factors as regular personal loan companies (credit score, debt-to-income ratio, employment history, even academic achievement and social media). For consolidating debt, Discover provides excellent additional services on its website, like free tools to manage debt and estimate monthly payments.
Personal for Business - These are personal loans given against personal credit for expenses related to your business. Some companies will require proof of business, but no actual tax returns or proof of income for said business. Prosper’s website has a section dedicated specifically to this type of loan, allowing borrowers to personalize their listing and tell prospective lenders about themselves and their business.
Business - These loans are actually issued to your business, and require its tax returns, forms, and bank statements to prove income. Some also have a minimum sales requirement. In this category, Lending Club is a great option, offering loans of up to $300,000 for almost any business expense.
At its core, P2P is an innovative form of fintech, a way to obtain money quickly at lower interest rates than those offered by more traditional lending platforms. For lenders, the high risk is made up for by the quicker return in the form of small repayments every month. Keep in mind that for a lender, Peer-to-Peer is not saving, but somewhere between saving and investing. Yields can vary wildly depending on the company, with some reporting as little as 1.9% to others claiming a 15.6% reported return rate, though most average around 5% to 9%. For borrowers, from individuals to small businesses, P2P can offer a potential alternative when the closed practices of traditional banking are too restrictive.
Chart is by: Farcaster at English Wikipedia