Advantages and Disadvantages of Peer-to-Peer Lending
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Advantages and Disadvantages of Peer-to-Peer Lending
Many of the pros and cons of peer-to-peer (P2P) lending arise from its directness and its lack of an intermediary. With no traditional financial institution to handle the lending process, there is far less expense for customer service, marketing, employees, rent, and other costs. This results in lower overhead costs for the borrowers and lenders. It should be noted that although there are no financial intermediaries per se, the P2P companies actually perform many of these same tasks themselves.
Things To Know
- Both pros and cons arise from the lack of an intermediary.
The pros
Higher potential earnings. Lenders can earn higher rates because there is little or no overhead that would otherwise take a bite out of earnings.
Lower interest rates for borrowers. Peer-to-peer lending often involves lower interest rates than those charged by traditional institutions.
It’s attractive to those with poor credit. Some would-be borrowers don’t qualify for traditional loans because their credit is poor or nonexistent. A P2P lending platform is therefore attractive to them. However, this access does not come without challenges; for example, those with bad credit may have to pay high interest rates on their loans.
Faster turnaround. Getting a loan approved and money transferred takes less time because there is less administration and thus less bureaucracy.
The cons
Defaults. Because P2P attracts borrowers with low credit, and because low credit is correlated with defaults, there is the risk of default to consider. Internet P2P companies have begun to address the danger of default by declining those with low credit scores, by requiring borrowers to pay into a compensation fund that works similar to insurance, or by putting up collateral … or by using a combination of these means.
Insufficient information about the borrowing requests. Traditional financial institutions have access to information about borrowers and their loan requests. They may even have research departments or pay for access to research about them. P2P companies have comparably less than this; often, the loan information is limited to the borrower’s description of it.
Insufficient regulation. While it’s not the Wild West in most cases, P2P is less regulated than traditional institutions. This can open it up to loan sharking and to lending based on illegal criteria, among other things. It also contributes to the rate of default.
Fewer services. Though this can cut overhead costs, some see a disadvantage in having barebones services.
Reintermediation. The benefits of being without a middleman can begin to die out as P2P companies grow and spend money on administration, product information, legal compliance, and other traditional costs. In other words, P2P lenders risk becoming the one thing they broke away from.
