How Does Peer-to-Peer Lending Work?
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How Does Peer-to-Peer Lending Work?
Peer-to-peer lending works by bringing borrowers and lenders together to set the terms of a loan and execute it. Most often, it occurs on an online lending site set up for that purpose. The site acts as a broker that facilitates the transaction. Unlike a brick-and-mortar institution that owns the loan, an online lending site can allow a single loan to be shared by many investors.
Things To Know
- Usually, lenders and borrowers meet on a site that lists loan opportunities
- Loans made on P2P lending sites must be registered with the Securities and Exchange Commission.
Having an official location, whether online or physical, to do the business provides some accountability and regulation.
In a nutshell
Usually, lenders and borrowers meet on a site that lists loan opportunities. Borrowers must first list their requests and provide information about the loans, about their creditworthiness, and about collateral, if any. The broker then evaluates the borrowers’ creditworthiness and provides a rating for it. Potential lenders then view the listings and ratings and evaluate the requests.
Lenders establish criteria for what they want to invest in, such as dollar amount and various other loan specifics. They then view available loans that match their criteria, and they decide whether and how much to invest.
Once a loan is complete, the borrowers begin making monthly payments and lenders receive a portion of those payments. The lender does not necessarily service the loan, however; the site itself may do that, or a third-party site may instead.
On some sites, there is an auction-like process in which lenders compete to set the lowest interest rate; the one who "wins" gets to give the loan.
The range of interest rates can vary greatly depending on the creditworthiness of the borrower.
The secondary market
Just as with home mortgage loans, loans originated via peer lending might be sold to other investors.
How is it regulated?
In the United States, loans made on P2P lending sites must be registered with the Securities and Exchange Commission, the federal government’s regulator of investments. This requirement came in response to unusually high default rates on loans in years past, and exists to provide some oversight over the whole process.
Soliciting investments from the public, which is the model that P2P sites use, is considered a sale of securities, and so a site must be registered as a broker-dealer if it is to engage in this lending.
