What Is Peer-to-Peer (P2P) Lending and How It Works?

Whenever you need money for a personal or professional expense, turning to friends and family is an age-old solution for Indians. People usually borrow loans from their friends, family, colleagues, and other acquaintances to handle the finances during emergencies. The basis of most of these loans is mutual understanding and trust. In such cases, both parties agree to the lending and repayment terms. The borrowers repay the loan amount in a lump sum or easy instalments. The borrowers may repay the amount in a lump sum or instalments. Usually, such loans do not involve any collateral or guarantee for security.

Just like several aspects of our lives, technology has also transformed this traditional form of lending. The new-age form of these loans is known as peer-to-peer loans or P2P loans. If you plan to borrow money from others without approaching a financial institution or NBFC, read this article. You will learn everything about P2P lending and know how it works.

What is Peer-to-Peer Lending?

Typically, people approach banks and NBFCs when they need money to cover a planned or unplanned expense. However, these financial institutions often reject loan applications due to inadequate paperwork, low credit scores, insufficient income, etc. In such circumstances, P2P loans from friends or family come to the rescue. However, you must have a strong mutual understanding, and they must feel confident to get their money back in time. The limitation of peer-to-peer lending is that you can borrow money from only a few people who can trust you for their money. That is when a P2P loan comes in handy.

The lending mechanism works on the principle of connecting potential borrowers and lenders through a platform. The system provides loans to borrowers who need money for an expense while investors lend money to earn interest on their investments. So, it is a mutually winning situation for both parties. Since the transaction occurs directly between the two parties through an app or website, it eliminates the requirement of any financial institution to work as a middleman.

Therefore, the P2P loan mechanism extends financial inclusions worldwide as a funding source. These loans are highly accessible even if you have a poor credit score, low income, or insufficient documents. Whether you need a loan to finance your wedding, education, start-up, medical emergency, or debt consolidation, P2P loan platforms make funding easily accessible with an instant loan application procedure.

History of Peer-to-Peer Loans

Peer-to-peer borrowing has always been a substantial market in India. A large number of Indians rely on their friends and family to finance their expenses even today. The global crowdfunding market is also evolving as a giant marketplace for P2P finance. The UK was the first country to introduce a P2P platform named Zopa in 2012. With its online expansion, people in need could access quick loans with no eligibility requirements and hefty documentation.

Since many Indians are still asset-light, P2P loans are popular among individuals and entrepreneurs today due to no collateral requirement. Currently, over thirty online platforms give fast Personal Loans, festival loans, Business Loans, etc., to people in need, and the number is continuously growing. The best derive their trust from easy loan application procedures, customer-friendly services, and minimum service charges. You can browse different loan plans and build a diverse and profitable portfolio based on your credit score.

In India, the introduction of peer-to-peer lending platforms like BharatPe and CRED has contributed to the boom. The segment delivers high returns compared to other asset classes. The investor base is witnessing consistent growth over the last few years, projecting promising numbers in the future.

Is Peer-to-Peer Loan Safe?

Yes, peer-to-peer (P2P) lending is safe in India as long as you borrow through an RBI-certified platform. These lending platforms connect investors and borrowers after thoroughly vetting them for trust and creditworthiness. Several regulations are also in place to ensure the safety of the transactions. The most important ones include the following:

• P2P platforms need membership of credit bureaus and make their financial data accessible to them.
• Lenders and borrowers are trustworthy for their financial worth, creditworthiness, etc.
• There are minimum and maximum limits to the lending amount across all lending platforms.
• Lenders must provide their net worth proof to lend an amount exceeding Rs 10 Lakh across any lending platform, and the proof should be certified by a practising CA.
• Borrowers can take ample loan amounts across various P2P platforms.
• One lender has a maximum limit on the amount they can lend to the same borrowers across any platform.

All these regulations work together to make P2P platforms safe for both lenders and borrowers.

Benefits of Peer-to-Peer Lending

P2P lending platforms match borrowers with relevant lenders through an online website or app. They enable borrowers to borrow loans at competitive interest rates. Some benefits of peer-to-peer lending are as follows:

Access to Capital for Borrowers

While many borrowers do not qualify for NBFC loans due to their income, credit score, debt-to-income (DTI) ratio, and other reasons, P2P loans are accessible to all, irrespective of their financial profile. Although these platforms check the borrower's creditworthiness before enrolling them for borrowing, they make loans available to all. The best thing is that these platforms have no strict eligibility criteria or documentation requirements. The platform confirms all details at the time of registration, making the process much easier and faster at the time of borrowing.

Diversification Opportunities for Lenders

Lenders can diversify their portfolios by lending loans to various borrowers instead of putting all their money into a single investment avenue. Besides bringing diversity into their portfolio, lenders can also spread their risk across multiple borrowers instead of lending a huge amount to a single borrower. Both lenders and borrowers have the freedom to choose their borrowers and lenders based on their risk appetite and credit profile.

Efficient and Transparent Process

P2P platforms work entirely online, which means the application process is swift, convenient, and handy to secure funds instantly. They connect borrowers with potential lenders waiting to lend loans, allowing borrowers to get the money they need in time. Since these are RBI-certified platforms, the charges are transparent, and procedures comply with the regulations.

Potential for Higher Returns

Compared to other investment options, P2P loans have the potential for higher returns for the investors. Since the authorities thoroughly examine the borrowers' creditworthiness and repayment capacity, P2P loans have lower chances of default. These loans are also beneficial for borrowers, as they are available at much lower interest rates than traditional loans, helping them save money on the interest cost. Since there is high competition between lenders on the platform, borrowers have greater negotiating power and higher chances of getting the best loan deals.

Processing Fees and Charges by P2P Lending Platforms

P2P platforms have different processing fees and interest rates for lending loans. Some examples include the following: