P2P might sound like the name of the latest Sony PlayStation video game console, but it’s actually more work and less play. P2P stands for Peer-To-Peer lending – a hot Internet trend on par with Grumpy Cat and planking (at least in financial circles, that is). P2P lending has brought investors and business owners together in a new way of borrowing and lending money without the middlemen. Unfortunately it has also opened up a new set of potential problems where investors may become the big losers in the end.
What Is Peer-To-Peer Lending?
Peer-to-peer lending involves borrowers seeking lending directly from private investors through an online investing platform. There are no banks involved in the process. Let’s say a borrower needs money to upgrade the equipment in their business. They could seek a peer-to-peer lending platform where they fill out an application for the loan. The P2P lending platform does a background check on the borrower’s credit history and debt-to-income ratio. Based on the credit findings, the borrower’s interest rates can be determined as the loan application is put up for an online auction. Some lending platforms will allow the borrower to set up the highest interest rate they will pay while the investor sets up the lowest interest amount they are willing to accept as they negotiate until coming to happy medium.
Borrowers find such an opportunity appealing because they may have been turned down by a bank for a regular loan. The interest rates for P2P lending is also usually lower than what regular financial institutions offer, appealing to borrowers, yet high enough where investors can make a nice return.
Investors can put up some of the loan amount, called “slices.” Normally, there will be several investors involved in financing the loan as they spread their investment about to obtain slices from many different loan-backing opportunities. Once the loan amount is reached, the money is sent to the borrower who now has the money they need.
Pitfalls of Peer-To-Peer Lending
P2P loans are still in their infancy with many people unaware it is an available lending option. Some investors are wary of working through P2P due to the lack of regulations in place on lending platforms. While the glamor of borrowers and investors working closely together to negotiate financing appeals to many, there are still issues that can seriously affect such a lending avenue.
The biggest issue is that P2P lending is mostly unregulated. There are no state-backed guaranties to such a lending platform because it is mostly done online and can cross international borders. A borrower may have dozens of foreign investors involved with the loan, yet there are no guarantees from any actual bank to those investors that they will be paid back for the loan if the borrower defaults.
Since there is no guarantee that the borrower will repay, an investor has to go through small claims court to recoup their funds. Also, what should happen if a P2P platform collapses or experiences some other major financial issue similar to what happened to Bitcoin and the Mt. Gox Tokyo Exchange back in February of this year? The exchange company misplaced half a billion dollars worth of Bitcoin as they filed for bankruptcy proceedings, leaving those people who invested in the exchange out in the cold with no way to recover their lost money.
Until further financial reassurance is into P2P lending, investors and borrowers should use caution and good judgment when testing the waters. If you decide to invest in such a lending platform, do your homework to ensure you will get a solid return on your investment.
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