Strangely and in a good way Peer-to-peer or P2P as it is commonly called, money lending model breaks down the financial borders. Also known as ‘social lending,’ this type of money lending model allows the individuals to borrow or lend money directly to and from each other.
This P2P money lending model works more like the eBay principle that eliminates the middleman between the buyers and sellers. There are no financial intermediaries such as banks or any credit unions when a borrower meets the lender with an intent to borrow money.
Ideally, P2P lending model helps the borrowers as well as the lenders in a distinctive manner.
- As for the lenders, it lifts the prospects of returns for supplying the necessary capital to the borrower and
- As for the borrowers, it reduces the rate of interests, making it much easier and more convenient for them to repay the loan.
However, P2P lending demands more effort and time to get the money from the lenders and it also entails much more risk for them. Nevertheless, this modern type of money lending is gaining popularity among the people by the virtue of its own.
Background of social lending
If you want to know more about P2P lending in a better way you will need to start from the basics and know a little bit about social lending background.
As it is money lending is a business that is performed by a few individuals and was in existence, predominantly, right from the ancient ages when barter system was replaced by modern form of currency trade.
At that time money lending was considered as an inferior practice and a lot of eminent people, priests, scholars and others condemned this practice. Even the Bible mentions money lending, considered then as ‘usury,’ as a sin!
However, the need for funding businesses made this form of business grow to its present stature wherein there are different forms and models of money lending followed. Today, you can borrow money from different sources such as:
- Credit Unions
- P2P lenders
- Family and friends and
- Online sources such as Liberty Lending and several other alternative sources.
P2P lending is ideally the product of a vital business, social and technological trends that includes a new generation called the ‘free formers.’
Concept of free formers and P2P lending
Free-formers are those people who combine social activism and personal freedom. Their primary objective is to take control of both, their work and leisure.
- They are the people who do not want to work for a particular company for 35 long years. Instead, they prefer collaborating in different networks for short periods and on many different projects.
- They are also extremely suspicious of large institutions like banks and believe in people more than these.
In addition to the free-former concept, there are other reasons that gave rise to the popularity of P2P lending and other forms of micro-lending. These reasons are:
- Disintermediation: In almost everything now disintermediation is noticed. This mass reduction of the intermediaries in their size and role of business across different industries is due to globalization, technological change, and other international trends.
- Web technologies: Over the years there has been a noticeable spread of web technologies. This fosters mass collaboration. Lot of new tools have been introduced that enable the individuals to work online in tandem and in huge groups in order to achieve their mutual goals.
Lastly, the development of microlending to people with limited assets in the developing nations have also given rise to P2P lending and other community and social-minded money lending entities such as credit unions.
In short, all of them have been around for a long time and has been playing a significant role in the money market and the finance industry. However, it is microlending that gave the required impetus to the idea of making small loans to the individuals to achieve social as well as business goals.
Different branches and legal issues
Another significant reason for the rise of P2P lending and its popularity is that it has many branches. That means you will get a lot of variety in P2P lending just like you would in most types of money lending.
However, the legal issues regarding P2P lending operations are yet to be settled, especially in the US. There are lots of questions that remains to be answered such as:
- What kind of an entity is a P2P lender?
- What is the regulatory regime that applies in this regard?
It is due to these concerns, the operations of foreign P2P lenders in the US are strayed far beyond the unique business models.
The working process
With all these admonitions in the fore, the working process of P2P lending in this typical scenario is a s follows:
- You sign up to become a member of a website of a P2P lender
- This lender then acts as your intermediary.
The lender typically performs a lot of other jobs such as recordkeeping, fund transfers among members, and more. For all these efforts the lending company earns its income through different fees charged to both the borrower as well as the lender.
The P2P lender will perform several checks on your employment, credit and personal aspects before you can borrow. Th lending standards however are relatively stringent and if you have a high credit risk, you cannot borrow.
- After you accept the terms and conditions, you will be offered with two or more choices.
- The P2P lender will also assign of the four or five risk categories to you.
- You will be allowed to borrow at the prevailing rate on the particular day you borrow according to your risk category.
You can your loan auctioned to the members having the funds to lend. The bidder will consider the pertinent information that you have provided on the site of the P2P lender. Your reasons to borrow, financial history, personal story, and personal matters will determine the initial interest rate of your loan and based on these facts the lender will accept bids.