Imagine this: You have a great business proposition, but the bank won’t even talk to you. Or this: You’re looking for a loan, but your credit rating has taken a hit. Sounds bad? Indeed, it does – until recently, after all, the only solution at your disposal were dodgy lenders offering outrageous rates. And yet, the advent of peer to peer lending has introduced a new, entirely different and previously unimaginable third solution to the equation: By creating a market place for private financial transactions, peer to peer lending systems have created fresh opportunities. By avoiding and sidelining some of the biggest disadvantages of big, bureaucratic banks, they allow for more flexible and individual loans. And despite the occasionally heavy criticism directed towards them, the idea has lost none of its potency.
The Mechanisms of Lending
How does peer lending work? Really, the underlying principle is almost as easy to comprehend as operating a cash teller: On sites like Zopa or Prosper, individuals rather than institutions are lending and borrowing, often at considerably lower rates than those available on the conventional market. It’s not entirely without its pitfalls, of course: Both as a borrower and a lender, you are dealing with complete strangers here, resulting in the risk of the borrower defaulting on his loan. And yet, by allowing those looking for credit to tell their story and present their case, a personal quality is entering the equation: As an investor, you can now select your cases not just according to their risk, but the biographies and ideals involved as well, supporting worthy causes and individuals hit hard by fate. In short, peer lending, at face value, seems to make sense in economic turns as a prime example of disintermediation – and it is more agreeable and personal than the bank-based models we have become accustomed to as well.
Four Essentials of Peer Lending
In an excellent article noted four important points with regards to peer lending, which anyone interested in taking up a loan through one of these sites – or any of the other ones on the wildly proliferating market for peer lending – should be aware of.
- As a borrower, you should be „realistic in the rates you ask for“. After all, with the risk for lenders potentially even higher than for a bank, there needs to be an acceptable financial compensation to make up for this.
- As previously mentioned, „part of the intrigue of peer-to-peer sites is that lenders get to know who they are funding“. What this means is that anonymity may be a precondition in the brick and mortar banking model – in peer lending communities, it is a guarantee for failure.
- Hoak also cautions that „loans might take awhile to get funded or might not get funded at all“, simply because there will never be enough capital to satisfy the demand by all those seeking for a loan through a peer lending site.
- Finally, you need to „understand the terms of your loan“ – which simply means that as with any borrowed money, you are expected to pay the specified amount back within a predefined time frame. Not being able to repay the sum is not a trivial offense, but a felony subject to prosecution.
If peer lending has considerably lost in reputation after hitting a euphoric high in its first two years, then this is partly due to too many borrowers and lending failing to recognise and respect these four points. Certainly, many of those expecting peer lending to be something of a fun-way to invest without any notable risk have been faced with the hard truth and ended up loosing plenty of hard earned cash. There have also been a variety of legal issues, which forced Prosper to temporarily discontinue their services. And yet, most of these simply relate to peer lending’s as yet undefined status between a marketplace for investment capital and an alternative to the traditional banking system – each of which is accompanied by entirely different legal implications.
Criticism of Peer Lending
Others, meanwhile, have maintained that peer lending is wrong from the outset. In his already mentioned article for the New York Times, aptly titled „The Gamble of Lending Peer to Peer“, Ron Lieber noted the multitude of issues the peer lending sector still faced, some of which could be defined as expensive beginner’s mistakes. Lieber cites Prosper’s Mr Larsen as claiming that, after various adjustments, “in some ways, the industry just starts now“ – which, to the author, „is a reason to wait a little longer before you invest much money.“ Some of those who failed to heed that advice have partly lost a lot money and are now suing Prosper for what they perceive as an inadequate information policy – or worse still. There are already blogs dedicated solely to making readers aware of the dangers of peer lending as well as a class action law suit against Prosper to compensate those with damages.
The Future of Lending
And yet, peer lending has neither gone away nor lost its promising glow. In a recent assessment, respected daily The Independent arrived at the conclusion that which should definitely be taken into account when looking for a personal loan. Their estimation seems to be the best piece of advice right now: Peer lending may not yet be the cure-all that some hoped it would be. But it is certainly far too easy to write it off altogether. Make sure to be careful – but do include peer lending in your considerations.