How Does Peer-to-peer Lending Work?

When you think of crowdfunding, you probably think of an entrepreneur gaining funding for a business or an individual gathering funds for a medical bill. You, too, can crowdfund though. That’s what peer-to-peer lending means.

Peer-to-Peer Lending 101

You either loan money along with a number of other individuals, then earn from the interest the borrower pays, or you’re on the receiving end of the money, getting one large cash loan from a number of micro investors. A P2P firm organizes the loans. The first of these organizations sprang up in 2005 and they’ve taken the lending world by storm, offering cash loans to those with mid-range to good credit.

How peer to peer lending works

Peer-to-peer Lending as a Borrower

Peer-to-peer lending makes obtaining credit more affordable for the borrower. While credit card interest rates continue to climb, the rates for peer-to-peer lending tend to remain lowish – around six or seven percent. That makes it a very affordable loan.

These peer-to-peer loans do not always carry the same level of credit check as a credit card or bank loan. They offer a ready alternative for those with mid-range credit scores that fall just under the prime borrower threshold. That makes them ideal for people who make their payments, but may have had one hiccup that lowered their overall score or those who have no credit whatsoever because they’re just starting out.

The prime borrowers have a credit score of 620 to 900. Those who could be considered to “just miss it” are those with a score in the high 500s to scraping 620. These individuals generally deserve the benefit of the doubt and a lower interest rate than a poor credit risk who has a score in the 300s or 400s.

Peer-to-peer lending lets them obtain money at a prime interest rate and gain an easier approval than other methods. They still only have a single loan payment each month – to the organization that handles the loan. That organization then handles the distribution of loan repayments to individuals who contributed to the crowdfund.

Peer-to-peer Lending as a Lender

As a lender, peer-to-peer lending provides a mutually beneficial method of investing with a strong rate of return on investment (ROI). With most savings accounts earning less than five percent interest and certificates of deposit (CDs) similarly comparable, investors looking for a lower risk investment with a higher rate of return can turn to peer-to-peer loans as an investment.Handshake icon

It remains a low-risk investment because, in most countries, the loans are covered in the same manner as others or in a similar manner. For example, in the United Kingdom, the Financial Conduct Authority (FCA) regulates P2P lenders, but the loans don’t receive protection under the Government’s Financial Services Compensation Scheme (FSCS). In the United States, the loans may be covered by the FDIC, depending on the lender.

In Europe, common platforms include RateSetter and Zopa. These organizations put together a platform that connects the lenders and the borrowers. They function as an organizer, not a lender. The lenders are the investors who are crowdfunding the loan.

The P2P firm keeps a small percentage of the money. It’s less than the loan fees that banks and other traditional financial institutions charge.

The investors make money on the loan by getting the interest paid on the loan. They make money the same way a bank would.

Peer-to-peer Lending as a P2P Firm

Companies putting together these loans, like Zopa and RateSetter, don’t do it altruistically. They aren’t charging fees like a loan shark either though. They charge a very small percentage for organizing the loan and “introducing” the lenders and the borrower.

Since their inception in 2005, these peer-to-peer lending firms have reached the billions mark in loans. Zopa topped more than £1 billion in loans. RateSetter has managed more than £800,000 million in loans.

While most of the firms offer person P2P loans, others specialize in business loans. Funding Circle brokers loans to businesses.

Lending for Everyone

Unlike angel investing, loaning money through a peer-to-peer lending institution doesn’t require you to be a billionaire or millionaire. Many of the micro lenders are just average people who have savings that they’d like to grow more quickly than a savings account allows them to do so.

There’s no minimum or maximum allowed. A lender may choose to loan $5 or $1,000. They determine how much money they want to loan and over what period of time.

The interest rates charged vary, but typically range between 7 and 8 percent. There is no typical loan amount, but there are “standard” options like taking out a loan for $3,000 for 36 months.

The terms are typically shorter than with other loan types. These are not designed to function as a mortgage or other long term loan type. They can provide a small amount though for emergency needs or for mid-sized purchases like a used or new car.

Risk Management

Whether you are the borrower or the lender, there are still risks. These are greater on the lender side. There’s truly no risk free investment.

As mentioned, these loans aren’t usually covered by organizations like the FSCS and FDIC. In the case of the FSCS, you’d be protected if you deposited funds of up to £75,000 with a financial institution. If the institution folded, you’d still get your money. The US’ FDIC works the same way, providing insurance to cover financial institutions that protects the funds each individual deposits.

Most peer-to-peer lending does not include this protection.

P2P firms generally create their own safety net system. For RateSetter, that’s a provisional fund that protects the lenders culled from fees charged to borrowers. It covers defaults and late payments. Zopa provides a contingency pot and spreads funds among a multitude of customers to minimize risk. The business lenders, like Funding Circle and Lending Works, also provide safeguards that protect micro lenders.

A combination of vetting borrowers through credit checks and selective lending has served to keep default rates low.

Peer-to-peer Lending Is Here to Stay

P2P have really taken off in the UK where the government continues to make it easier for both sides to get involved. In the UK, micro lenders can enjoy earning their interest payments tax-free because the country began allowing P2P loans within individual savings accounts (ISAs).

There’s also another wave of crowdfunding P2P sites developing. The newer sites specialize in risky start-ups. They are crowdfunding to “create” an angel investor sized investment. These new sites do not create the safety net fund that established P2P firms like Zopa and RateSetter do.

The new startup loan sites carry a much higher risk than other P2P firms.

These sites do not yet have brokerage track record nor do they have a history of accounts. They’re a new version to a now established lending method. Those specializing in startups model the P2P loan much closer to that of an actual angel investor. You are taking on the same level of investment risk as you would if you loaned the startup money directly. You are simply able to do it with a smaller investment than an angel investor.

Unlike direct investment as an angel investor, you may not get much information on the startup through a peer-to-peer lending firm. As Saga points out, this makes predicting the viability of the business challenging. Most of the newer companies that specialize in these loans do not require a business plan for the borrowers. You won’t get to read this in advance of making the loan therefore. Chances are you won’t even know if the startup already has its minimum viable product (MVP) developed or still in the works.

You’ve Got to Keep It Regulated

While the lending type and its organizations have not existed long in comparison to other types of financial lending institutions, all P2P firms have the opportunity to join the Peer-to-Peer Finance Association (P2PFA). This trade organization admits only members who have passed vetting tests and adhere to a specific, stringent rule set. The P2P firms specifically named in this article – Funding Circle, Lending Works, RateSetter and Zopa – all belong to P2PFA. Check the Association to ensure that the P2P firm you’re considering using as a borrower or lender belongs to the P2PFA.

Each country has its own industry/trade association. Look at the P2P firm’s location. If it is a US firm, it will use a different association. That’s why you likely won’t see Lending Club, Prosper or Sofi listed in the P2PFA. Some companies that do business internationally, on the other hand, may meet the criteria for more than one organization, so you may find some firms listed among those in more than one trade association.

Why Apply for a Peer-to-peer Lending Opportunity?

As mentioned, these loans really aren’t for the mega huge needs like mortgages. You can obtain smaller loans for auto loans, debt consolidation, home improvements, medical bills and travel. Some sites, like Sofi, let you refinance your student loans using peer-to-peer loans.

Essentially, any need small enough to tantalize you to take out a credit card is fodder for a P2P loan. You’ll get a much better interest rate, typically.

Your Credit Score Still Matters

Rather than the bank checking your credit score, the peer to peer lending platform performs the due diligence check. Only if your credit score passes their muster will they then offer your loan need to their investors.

That means you still need to ensure that your credit score is as healthy as possible and your credit history accurate. Visit Creditry to get started. You can make sure your credit score can obtain you a favorable loan rate before applying.

The P2P firm examines your credit score just like a bank would. They look at how many, if any, payments you made late or skipped. They look for any loan defaults.

if your credit report reveals you have healthy credit, the P2P firm will score your loan for risk and offer it to their lenders/investors. The loan score helps the lenders understand how risky the loan is. That score lets them understand in a single number how much interest they’ll likely get returned versus the risk of the loan going unpaid.

Each site varies in the minimum amount of a loan a lender can purchase. At some sites, it is $10. Others start at $25. The top out is the entire loan.

Typically, the loan gathers investors for up to 14 days on the site. During that time, investors bid on or buy portions or all of the loan. One investor can purchase the entire loan although that is rare for a single investor to take on a loan. That means this is not an option for fast loans.

Strengthening Your Credit Score

You need to strengthen your credit score as much as possible before applying for a loan through any type of lender. You probably think of bad credit as someone with a score of 300, the lowest you can get. That is not how a financial institution thinks. Credit scores go up to 900, but anything beneath a score of 640 tells a financial lender of any type that you make a poor lending risk.

credit score factors

You might consider your score of 540 pretty good, but banks see it differently. Financial institutions know you don’t have to be rich to have a strong credit score. You just need to manage money really well. Many people of normal means have high credit scores. So, when a peer-to-peer lending institution sees a lower credit score, they see a person who doesn’t manage money well. Change their perception by learning to manage money better.

The advice that works to raise your credit score probably won’t surprise you. Between TV commercials and your parents, you’ve probably heard it all before. Listen. You can raise your credit score by doing such simple things as checking your credit report and paying your bills on time. Here are the specifics of what you need to do to raise your credit score and achieve a better perception of yourself by financial institutions.

1. Run Your Credit Report

Look at your report both as yourself and as a lender would. It’s free to do obtain your full report once per year. Obtain a report from each of the three major credit reporting agencies.

Check the credit reports for errors and inconsistencies. Not every agency will have the same data because some of them collect more data. For example, Experian lets individuals opt into a collection of data from their utility and cell phone payments. The credit reporting agency then includes this in the calculation of the score. You can only do this by visiting the Experian site, opting in and providing your utility information. Only this credit reporting agency will obtain this information.

Immediately report any spotted errors or inconsistencies to the credit reporting agency. You’ll need to document your proof of the correct information. Include proof of payment, credit card or bank statements showing the payment dates and accounts. It will take a few weeks for the agency to correct the data, but once they do, your score gets recalculated.

2. Avoid Late Payments

As basic as it sounds, the underlying key to having stellar credit is to pay your bills on time. Even if in the past you made late payments, you can increase your credit score after only six months of making all your payments on time. It increases your score that quickly.


You can consolidate your loans, using a non-profit agency such as CareOne. They will contact each creditor for you and negotiate a restructured debt. After negotiating with each creditor, they’ll combine them all and you’ll make a single payment to the non-profit each month. The organization then distributes the newly negotiated payment to each creditor. This lets you quickly reduce your overall debt, plus unless you miss a payment to the non-profit, your payments are never late. That factor, plus the reduced debt, quickly raises your credit score.

3. Increase Your Income with a Side Hustle

Maybe hustle harder doesn’t sound fun. It can save you money though. While loans cost you more money than you need, a side hustle does nothing but bring you income. You can pay down your debt with the income. So, add another stream of income.

How to Calculate Your Debt-To-Income Ratio Accurately?

You can also ask for a raise if you have been with your current employer for a while. If they do not have a regularly schedule performance raise dovetailed with their annual performance reviews, ask for a raise as long as you have performed well at your job.

Get a second job or start freelancing. It is pretty easy to land a job in retail or fast food or waiting tables. They might not be glamorous gigs, but they pay decently nowadays. Most employers start you at $10 to $12 per hour. Work at the job for about six months before applying for a loan. Heck, having the job can prevent you from needing the loan.

Either bank the money you earn from your second job or use it to pay off existing credit cards and loans. This reduces your debt-to-loan ratio and that raises your credit score. If you choose the savings account option, you should take the account statements to the loan officer to show that if you did lose your job for a few months, you’d have means to still pay the loan payments.

Freelancing lets you set your own hours and earn money. It does not require professional training for many positions such as appointment setter, personal assistant, typist, transcriber, Lyft or Uber driver, etc. This won’t give you traditional pay stubs, but you can sock away your pay in a savings account to list on a loan application.

4. Plan It Out With a Budget and Loan Calculator

There’s nothing simple about getting a loan or improving your credit. You have to improve your credit to get a loan. One way to do this is to make a budget and stick to it.

Look at your current budget. If you do not have one, create a budget. You should have at least 30 percent of your income available before taking out a loan. That is because your total loan repayments including the loan you are hitting up the peer-to-peer lending institution for should not exceed 30 percent of your monthly income.

Use a loan calculator to calculate what you can comfortably afford. Do not try to take out a loan for the absolute maximum for which you qualify. This is just a bad idea that can land you in a lot of trouble if anything happens that makes you late for a payment or two. Use the calculator to figure out your potential monthly payments using various options for loan term and interest rate, plus down payment, if that applies.

What If You Do Not Qualify for a Peer-to-peer Lending Institution?

It is not the end of the world if you do not qualify for a loan from a peer-to-peer lending institution. While those who just miss qualifying as prime borrowers probably can qualify, many do not. You can still obtain a loan elsewhere. Once you feel ready to apply for a loan, visit Loanry.com to start loan shopping.

Loan Shopping with Loanry

Loanry does not offer peer-to-peer lending. In fact, it offers no lending whatsoever.

Wait. What?

That’s right. Loanry is a loan mall. You visit it like you would the shopping mall only instead of hitting up Gap or Dillard’s for jeans, you shop for a loan among many lenders.

Loanry provides individuals and businesses with a simple process for finding a lender. Its’ participating institutions offer a plethora of loan types, including those loans geared for those with bad credit or no credit. Fill out a form below to use this loan mall that makes finding a lender is a breeze.

Alternatively, you can compare lenders using their money tools.

As mentioned above, Loanry does not make loans.  It allows them space to interact with consumers similar to the stores in a shopping mall. Your loan may come from a financial lender if they decide to lend you money and you accept their terms.

Loanry’s site offers may types of loans, for example, auto loans or home renovation loans.

It also may save you time going to too many banks or financial lenders whose qualifications you did not meet. The Loanry tool cuts your research time, so can determine the appropriate lenders to approach more quickly.

Other Benefits of Using Loanry

Using it also reduces the number of requests on your credit report. These report requests happen every time you apply for credit, no matter what type. Each request lowers your credit score just a little. If you apply for many credit cards and loans, you may reduce your score, even if you did not take any out or were refused for each one.

While Loanry is not a lending institution, it does offer educational articles to help its users make better decisions about money. It offers these financial educational articles for free.

Once you are ready to apply for loans, you may find that your bad credit limits your lender options. Before you go to a loan shark, explore your other options. While you will still end up paying higher interest than someone who could afford a prime interest rate loan, you do not have to resort to that high of an interest rate. You do have alternate options though since the Internet has spawned the peer-to-peer craze.

If you qualify for a peer-to-peer loan, you’ll pay much lower fees than you would with a bank. For example, Lending Club and Prosper may charge 1 percent annually on the principal amount an investor loaned.

Peer-to-peer Lending as an Investment

No one is being altruistic when they loan money through a P2P firm. Many millennials are using P2P lending as a starter investment. They view the stock market as more chancy. They also cite the good feeling of helping others as a reason for offering P2P loans.

Perhaps you never considered making an unsecured consumer loan as an investment opportunity, but it is the new thing. The borrower does not have to offer any collateral, so there are no guarantees you will get your money back, but many of the P2P firms have built-in protections, as mentioned.

Statistic: Value of global peer to peer lending from 2012 to 2025 (in billion U.S. dollars) | Statista
If the borrower does default and you used a P2P firm that does not provide a contingency fund for repayment in such cases, you have a couple of options to recoup the money.

  • You can use a collection agency to obtain repayment.
  • You can sell the loan on a secondary market.

Both options require a time investment and neither guarantees you will recoup the funds. While you may recover the funds you loaned, it takes longer than if the borrower had simply repaid on time.

In Conclusion

Peer-to-peer lending provides an emerging alternative for both borrowers and lenders, the latter as an investment opportunity. While those with bad credit will still need to apply for sub-prime loans, those with fair or good credit can turn to peer-to-peer lending as an alternative. This option nets them a much lower interest rate and can provide better loan terms in some cases.

Those with poor credit can still use options like Loanry.com and Cashry.com to locate traditional lending institutions that extend loans to those with sub-prime credit. A loan shopping site makes it simpler for people to find loans. If you do not qualify for a P2P loan, you may still be able to obtain the money you need by taking out a loan, albeit at a higher interest rate, from a traditional lender.

Be bold. Try out peer-to-peer lending whether you need to take out a loan or you would like to experiment with making loans. You can obtain the money you need or make money by using P2P lending as an investment.