Peer-to-peer (P2P) is a type of direct financing to businesses or individuals without the need for the involvement of official financial institutions as intermediaries. This form of lending is often done through online platforms where lenders meet and match with potential borrowers. Due to its nature, loans offered can be either secured or unsecured, though statistics indicate that most of the loans are usually unsecured personal loans. Secured loans are rare and are often backed by luxury goods. Since it has unique characteristics, P2P lending is considered an alternative source of finance.
Pros and Cons of P2P Financing
This financing option offers advantages to both lenders and borrowers. For the investor, there is usually a potential to earn higher returns. This is because P2P financing generally provides more returns to investors compared to other investment options. For the borrower, there is an ease of access to a source of finance. For many borrowers, P2P lending is more accessible compared to traditional loans offered by financial institutions. This is so because P2P lending does not require high credit ratings or declaration of the unusual purpose of the loan. Besides, this form of lending offers borrowers reduced interest rates due to lower origination fees and the high competition among lenders.
While P2P lending is highly beneficial to both lenders and borrowers, it has some disadvantages. One of the cons is that there is no government protection or insurance. In this case, the lenders can potentially suffer losses if the borrower fails to pay back because governments usually do not offer insurance or any other form of protection to the investors or lenders. Also, peer-to-peer loans are typically exposed to increased credit risks. Many P2P loan applicants often have low credit ratings that prevent them from obtaining conventional loans from banks. Therefore, the lender always stands the risk of the borrower defaulting.
In summary, Peer-to-peer lending is a unique financing option that is readily available for many potential borrowers. Despite its disadvantages, P2P lending is a great financing option for many low-credit borrowers and a profitable venture for lenders.