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What is Peer to Peer Lending and How Does it Work?

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Peer to peer lending (P2P) is a relatively new breed in the online investment space. The phenomenon essentially removes the middleman by allowing everyday consumers to lend their money out to other people, or to companies. 

In theory, this benefits both parties involved. On the one hand, those lending out their money essentially get to play the role of a bank, insofar that they will receive interest payments from the borrower. 

On the other hand, borrowers benefit from obtaining financing without needing to go through a traditional bank or financial institution. 

With that being said, we’ve created the ultimate 101 guide to P2P lending, with our content providing value for both borrowers and investors.  

This includes a thorough breakdown of what peer to peer lending is and how it works, the pros and cons for both the investor and the borrower, an overview of some of the best lending platforms in the online space, and more. 

What is Peer to Peer Lending for Borrowers?

Peer to peer lending is a process that seeks to remove the need of using a third-party intermediary. The process dates back to the 1990s, with peer to peer platforms such as Napstar and LimeWire allowing users to swap music, videos, and other media files on a direct basis. Fast forward to 2019 and the P2P experiment has made its way to the conventional lending space. 

In order to better understand, let’s look at a quick example of how a peer to peer lending transaction might take place.

  1. John Doe wants to borrow $20,000 to help fund the downpayment on his new home. Instead of using a financial institution, John decides to borrow the money from a peer to peer platform.
  2. The P2P platform contains thousands of individual investors of all sizes. Instead of John borrowing the money from a single investor, the loan will be made up of multiple individual lenders, at various amounts.
  3. To keep things simple, let’s say that 100 individual investors contribute $200 to John’s loan, which amounts to the full $20,000 requirement. 
  4. As it would be a logistical nightmare to make 100 repayments each and every month, John would instead make one payment directly to the P2P platform in question, from where the money would be forwarded to individual investors.

The above example is peer to peer lending in its finest form. It is important to note that the process is not only suitable for individual borrowers. On the contrary, the P2P process is heavily used by small-to-medium businesses, too. One sector in particular that has benefited from peer to peer lending is that of the real estate development. 

As developers often struggle to obtain the required financing from traditional lenders, the peer to peer lending arena has created alternative funding sources. In return, investors are often paid a healthy rate of interest, which ultimately reflects the somewhat high-risk nature of the loan.

What is Peer to Peer Lending

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Benefits of Peer to Peer Lending for Borrowers

Let’s take a look at some of the benefits of peer to peer lending from the perspective of the borrower. 

Low Rates

The amount of interest that you pay on a loan issued by a traditional bank will vary quite considerably in the US. On top of the amount that you borrow and the length of time you choose to pay it back, your individual rate will be dictated by your financial profile. Nevertheless, average APR rates in the US will vary from 13.9% for excellent credit, up to a whopping 27.2% for those with a bad credit score.

Over in the peer to peer lending space, the APR rates on offer are typically much lower. While rates will of course vary depending on the P2P Lending platform, as well as the financial profile of the borrower, APR rates often sit between the 5% and 12% range. In comparison to the aforementioned average APR rates offered by the US banking system, this has the potential to save you a considerable amount of money.

Let’s look at a quick example to highlight the disparity in interest costs, based on somebody that has excellent credit.

$10,000 loan with a US bank: As per the most recent averages published by Bank Rate, a consumer with excellent credit would pay 13.9% APR. Across 60 monthly payments of $232.16, the total loan would end up costing you $13,930.86. This equates to $3,929.86 in interest.

$10,000 loan with a peer to peer lending platform: With P2P lending platforms typically offering APR rates from just 5% for those with excellent credit, let’s make the comparison. You would instead make 60 monthly payments of $188.71, amounting to a total loan amount of $11,323.74. This amounts to a total of $1,322.74 in interest.

For those of you without a calculator on hand, this means that by obtaining a loan with a P2P lending platform when in excellent credit standing, you would potentially pay $2,607.12 less interest. 

Origination Fee

For those unaware, origination fee relates to the fee charged by traditional lenders for arranging the loan. In the US, this averages between 0.5% and 1% of the principal loan amount. However, if your credit rating is less than ideal and you are required to use a specialist lender, this can actually cost as much as 5% of the total loan amount.

Irrespective of the amount you pay, the origination fee is subsequently reduced from the amount that you receive. For example, if you were to borrow $20,000 on a loan that came with an origination fee of 5%, then you would only receive $19,000—even though you would have to pay back the full $20,000.

Although it is true that origination fees are usually charged for using peer to peer financing, they are typically lower than what you would pay in the traditional banking space. Even if you do not benefit from a reduced origination fee, your lower APR rate should more than make up for this. 


Obtaining a loan from a traditional financial institution can be a highly cumbersome and slow process. You might be required to visit your local banking branch, fill out a range of application forms, provide countless documents—and still not obtain a decision as to whether or not your loan was approved.

On the contrary, peer to peer lending platforms are often able to facilitate loans considerably faster. One of the main reasons for this that a number of peer to peer websites utilize the benefits of emerging technologies such as machine learning, robotic automatic processing and artificial intelligence. 

Such technologies allow peer to peer platforms to validate your personal and financial information in an automatic manner, subsequently providing you with a near-instant decision on your loan application.  

Low Credit Score Barrier

Peer to peer lending platforms also offer greater levels of flexibility when it comes to servicing loans for those with less than ideal credit scores. Although the platform will still need to assess your ability to repay the loan, being in possession of bad credit won’t necessarily mean that you don’t qualify. Instead, your rate of interest will correlate directly to your creditworthiness. 

From the perspective of the lender, peer to peer platforms allow lenders to choose the risk category under which they want to loan money. For those that have a higher appetite for risk, they might decide to allocate some funds to bad credit borrowers. 

How P2P Works

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Types of Loans You Can Access

The peer to peer lending space has grown rapidly in recent years, with multiple types of loans now on offer. Here’s a breakdown of what the industry can finance.

Personal Loans

The vast bulk of the peer to peer lending space is dominated by personal loans. Getting an unsecured loan, borrowers are not required to put any collateral against the loan, such as their home or a car. 

The amount of money that you can borrow will depend on the platform in question, as well as your individual credit profile. However, this will typically average an upper limit of $35,000, with a maximum loan term of 5 years. 

Due to the competitive APR rates that come with a peer to peer personal loan, a lot of consumers use the process as a way to consolidate debt. In other words, borrowers can pay off their outstanding loans in full by taking out a peer to peer loan at a much more attractive rate of interest.

Business Loans

The peer to peer lending industry has also expanded to business financing. This is especially useful for small businesses that would otherwise find it difficult to obtain financing, not least because they don’t have the required track-record that traditional banks look for.

As we noted earlier, the threshold is often much lower at peer to peer lending platforms, making it perfect for businesses of all sizes. Platforms such as Funding Circle are able to facilitate business loans of up to $500,000, with APR rates starting at just 4.99%.


Although still in its infancy, a number of peer to peer lending platforms are now offering traditional mortgages. This is an area that requires significant research from the borrower, especially considering the complexities of mortgage agreements. 

Nevertheless, if the rates available in the personal and business loan sectors of the peer to peer industry are anything to go by, you might be able to obtain a highly competitive rate on your mortgage application.

Real Estate Development

As previously discussed, one of the most popular sectors of the peer to peer lending market is that of the real estate development. Although developers need ongoing financing to help pay for new real estate projects, traditional banks are often reluctant to lend the required funds. 

On the contrary, there are now a number of platforms that specialize purely in peer to peer financing for real estate developers. From the perspective of the borrower, the loans are typically classified as high risk. However, interest rates average 8%-12%, which reflects the underlying risk. 


Launched as far back as 2006, Prosper is an online peer to peer platform that offers personal loans to borrowers that have a credit score of at least 640. Once the Prosper system has assigned you a credit rating, investors will then be able to decide how much to lend you. 

Lending Club

Lending Club is one of the most established platforms in the peer to peer arena. The platform offers loans from just 6.5% APR to those with a credit score of at least 660. According to Lending Club themselves, two-thirds of loan applications are rejected by the platform—so if your credit is less than desirable, you might not be suitable.

Lending Loop

Lending Loop is a Canada-based platform that specializes in peer to peer small business loans. Loans start from just $1,000 all the way up to $500,000. This comes with a starting APR rate of just 5.9%, which is very competitive.


Peerform is a US-based peer to peer lending marketplace that focuses on unsecured personal loans. Loans of between $4,000 and $25,000 are available on the platform, with APR rates ranging from 5.99% to 29.9%. As such, borrowers of all sizes are considered. When you make your initial application detailing your requirements, your profile will be posted to the Peerform marketplace. This then gives investors the option to contribute funds to your loan.


Launched in 2012, Upstart is a peer to peer platform that offers personal loans between $1,000 and $50,000. While traditional lenders typically focus exclusively on your credit score, the Upstart algorithm looks at other metrics such as your education, areas of study and job history. This is great for borrowers that have a less than ideal credit profile, but have since recovered.


StreetShares is a niche peer to peer platform that offers small business loans to US veterans. Launched back in 2013, loans start at just $2,000, up to a maximum of $250,000. StreetShares can also facilitate lines of credit and invoice factoring—up to a maximum of $250,000 and $5 million, respectively.

Funding Circle

Funding Circle is a platform that offers business loans to small-to-medium companies in the US. Loans start from just $25,000 up to $500,000. The platform claims to have facilitated more than $2 billion in business loans, which is impressive for a platform that only launched in 2010.

Peer to Peer Lending Pros

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Is Peer to Peer Lending Safe and Legit?

The peer to peer lending industry is now regulated in the US, as well as other leading markets like Canada and the UK. Platforms must comply with multiple regulations pertaining to fair lending practices, privacy, anti-money laundering, security, and consumer protection. With that being said, borrowers can use peer to peer lending platforms in quite a safe environment

Although peer to peer platforms must comply with their regulatory obligations, the risks are ever present for investors. Ultimately, there is always the chance that the borrower will default on their loan repayments, meaning that lenders could lose money. 

This is why it is always advised to diversify as much as possible. It would be wise to split your investments across hundreds, if not thousands of individual borrowers. In doing so, you won’t feel the effects of a default anywhere near as much as you would by lending to a single borrower. 

Pros and Cons of Peer-to-Peer Lending

Pros For Borrowers

  • Cheaper APR rates
  • Potentially lower origination fee
  • Credit profiles of all shapes and sizes considered
  • Much faster loan application process
  • Covers personal loans, business loans, mortgages, and more
  • Avoid the bureaucracy of traditional banks
  • Lower eligibility criteria
  • Unsecured loans (collateral not required)
  • No prepayment penalties

Cons For Borrowers

  • Interest rates are high for those with bad credit history
  • If you require a large amount, it may not be available

Pros For Lenders

  • Access to a lending market that has traditionally been reserved for financial institutions
  • Range of risk levels to choose from
  • Chance to earn passive income
  • Diversify across thousands of individual loans
  • Lots of different loan types available
  • Invest with small amounts
  • Higher return of investment

Cons For Lenders

  • Higher risk of defaults as the loans are typically uninsured
  • Lack of regulation and framework to govern P2P lending
P2P Pros and Cons for Lenders

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Is Peer to Peer Lending Right For You?

For Borrowers

  • You are unable to obtain financing from a traditional bank
  • You are looking to reduce your financing costs
  • You are confident you can afford to repay your loan on time
  • You need access to fast cash
  • Your business needs working capital

For Lenders

  • You’re looking to earn passive income
  • You have a slightly higher appetite for risk
  • You want to achieve higher rates of returns

Final Thoughts

If you’ve read our comprehensive guide all the way through, you should now have a good idea of what peer to peer lending is and how it works. Most importantly, you should also be able to make an informed decision as to whether the peer to peer lending process is right for you. 

If you are a borrower, then you have nothing to lose by simply finding out what rates of APR are available. If it turns out you’re able to save a considerable amount, then it is well worth considering obtaining your financing needs via a peer to peer platform. 

On the other hand, if you’re an investor and thinking about loaning funds out through a peer to peer platform, then you need to make some serious considerations regarding risk. While it is true that the rates of return can exceed 12%—especially if you’re lending to a real estate developer, you need to remember that there is always the chance that the borrower will default. If they do, you could lose your investment. 

Ultimately, with the peer to peer lending market now under the watchful eye of industry watchdogs, it’s likely that the phenomenon is only going to keep on growing.