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Peer-to-Peer Lending

New start-ups have disrupted the personal loan industry. The result? More options for peer-to-peer lending. Now, despite the name, to get a personal loan from a peer-to-peer lending site you don’t actually need to know or meet your lenders. Peer-to-peer lenders connect folks who are looking for loans with folks who are looking to invest – and they do it quickly. Here’s how it works.

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It used to be that if you wanted a personal loan you had to go to a bank, submit an application and wait for the underwriting process to take its course. Now, you can be approved for a personal loan from a peer-to-peer lending site in a few days or even a few hours. Ready to hear more?

Peer-to-Peer Loans: How They Work

Peer-to-Peer Lending

Getting a peer-to-peer loan is as easy as finding an online lending site and entering some personal details. These will include, at minimum, your name and the size of the loan you want. Be prepared to share your income and savings levels, too. Depending on the peer-to-peer lending service you use you may have to provide all or part of your Social Security number and authorize a credit check. Although you’ll enter personal information, lending companies won’t share details like your full name and address with the “peer” who takes on your loan.

Some sites require would-be borrowers to list and explain the purpose of the loan they’re seeking. These loan sites cultivate a “personal touch” by soliciting applicants’ stories about what they would do with the money they’re seeking. If you’re seeking a personal loan for a small business or professional development course, it can be a good idea to talk it up in your application. If you’re seeking a personal loan to consolidate your credit card debt, you may be better off with a peer-to-peer lending site that doesn’t require a sales pitch.

Peer-to-peer lending offers two main advantages to would-be borrowers. First, the loans are easier to get than bank loans. Second, they offer lower interest rates for customers of comparable credit risk. A recent college grad with a good job but thin credit history will likely have better luck getting a loan from a P2P site than from a traditional bank. A borrower with good credit will probably get lower interest rates from a P2P sites than from a traditional bank. Not bad, right?

Peer-to-peer lending companies have less overhead than traditional banks. They can also afford to take more risks on applicants with low or poor credit. Many of them consider factors in the underwriting process that banks don’t use, opening up an entirely different customer base not previously served by the personal loan industry.

 Peer-to-Peer Loans and Your Credit

Peer-to-Peer Lending

Some peer-to-peer lending sites deal exclusively in loans for folks with average or above-average credit. Others will provide peer-to-peer loans for people with bad or nonexistent credit but charge a higher interest rate for the privilege.

If you have bad credit, no credit or thin credit, a peer-to-peer lending site may be the only way you can get a personal loan that’s not an expensive payday or installment loan. Building and rebuilding credit are both important financial goals. It’s important, though, to be careful not to apply for a loan that you can’t afford.

Not all peer-to-peer lending sites and organizations will report your loan payments to the three major credit reporting agencies. If you need to build or rebuild your credit, it’s a good idea to shop around for a lender that will report your payments and help your score reflect your responsible use of credit. And don’t worry. When deciding what rate to offer you, peer-to-peer sites generally run a “soft” credit check that won’t ding your credit.

When comparing loan offers from different peer-to-peer lenders, don’t just compare interest rates. You should also compare any flat percentages fees that come with the loan. These are sometimes called origination fees or closing fees, and generally range from 1 to 5% of the loan.

Related Article: 3 Personal Loan Mistakes You Can’t Afford to Make

Peer-to-Peer Lending Sites

Although peer-to-peer lending sites are relatively new, a variety of options already exists. You may have heard of some of them, like LendingClub, Prosper and Upstart. Some peer-to-peer lending organizations are more like charities. They help form lending circles so that folks who need personal loans won’t have to resort to payday loans or installment loans. These groups don’t charge much – if anything – for the loans they facilitate.

Other sites charge higher interest rates than the non-profits, but still offer rates that are generally lower than what you’d get from a traditional bank. These sites are facilitating loans, but they’re also facilitating investment. Did you know that big hedge funds trawl peer-to-peer lending sites and build up portfolios of loans? Well, they do. Nowadays, many peer-to-peer lending sites are more like big institutional investing firm-to-regular person lending sites.

The fact that investing in peer-to-peer lending has become big business can work in your favor if you have bad credit or thin credit. As investors build up their loan portfolios, they’ll include some loans with low rates and low default risk, but they may also include loans for people with bad credit, taking a chance that the higher interest rates outweigh the higher risk of default.

Some sites have underwriting processes that break the mold. Instead of just asking about your income and savings and running a credit check, they’ll ask you about your high school GPA and where you went to college. As you fill out your loan application, it’s important to answer all questions honestly and be prepared to document anything you include in your application.

Related Article: Should You Try a Lending Circle?

Bottom Line

If you need a personal loan and don’t want to go through a major bank or submit to the terms of a payday lender, peer-to-peer lending may be a compelling alternative. Be sure to shop around for the best rate you can get, and avoid signing up for a loan that comes with prepayment penalties or tries to hide extra fees. Put yourself on a budget so you can be sure to have enough money to make your loan payments. Don’t take out a loan that will keep you from meeting other financial goals like keeping up with your mortgage payments. Then spend that loan wisely!

© iStock/pixdeluxe, © iStock/Hailshadow, © iStock/Jacob Ammentorp Lund

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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