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Peer-to-Peer (P2P) Lending In 2020: The Ultimate Guide

What Is Peer-to-Peer Lending

Peer-to-Peer (P2P) lending enables individuals to obtain personal or small business loans directly from other individuals, cutting out the financial institution as the intermediary. Websites that facilitate Peer-to-Peer (P2P) Lending have significantly increased its adoption as an alternative method of financing.

Peer-to-Peer (P2P) Lending is also known as social lending or crowd lending. P2P Lending websites connect borrowers directly to lenders. The site sets the rates and the terms and enables the transaction. Most sites have a wide range of interest rates based on the creditworthiness of the borrower.

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How Peer-to-peer (P2P) lending works

Traditionally, anyone who wanted to take a loan, individuals or businesses, had to submit an application to the bank. The bank in turn would run extensive financial background checks to determine the borrowers credit score and loan history to determine if they qualified for a loan and, determine the interest rate that was charged on the loan.

Getting a loan from a bank demands higher interest rate and collateral. This is where alternative methods of lending like P2P Lending come to play. Individuals or SME owners can borrow smaller amounts of money from individuals with ease.

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With Peer-to-Peer Lending, borrowers take loans from individual lenders who are willing to lend their own money for an agreed interest rate. The profile of a borrower is usually displayed on a P2P Lending platform, where lenders can view borrowers profiles and decide if they want to lend money to them.

A borrower might receive the full loan amount or only a portion of what he asked for from a lender. In the case of the latter, the remaining portion of the loan may be funded by one or more lenders in the peer lending marketplace.

Benefits of Peer-to-peer (P2P) lending

  • Online application for a P2P Lending loan is quick and convenient
    As peer-to-peer lending platforms are typically entirely online, it means that the application process is fast and convenient. This can be very handy if borrowers wish to secure his funds quickly. Most P2P Lending platforms have a waiting list of lenders to provide loans to borrowers which, when combined with an auto-invest option, means turnaround time on getting your money can be very quick - sometimes as little as a couple of hours.

  • Borrower may be able to access lower rates
    With peer-to-peer lending, borrowers can often access loans with interest rates lower than they could obtain from traditional lenders like banks and NBFCs. As lenders are providing money directly to borrowers through a P2P Lending platform, there aren't the typical overheads associated with most financial service providers, which often allows both parties to benefit from more favourable rates.

  • Getting an initial quote will not affect credit score
    If borrower is interested in getting a personal loan through Peer-to-Peer Lending, he/she can get a personalised quote that doesn't affect credit score. This will give borrowers a better idea of the rate he/she will be offered and the affordability of any prospective loan.

  • P2P Lending provides another option for a loan to conventional lenders
    For those looking for an alternative option to traditional banks, a Peer-to-Peer loan provides a great alternative that is well worth exploring.

  • Though loans are from individual lenders, borrowers only need to deal with the P2P platform
    Even though Peer-to-Peer loans are financed by multiple lenders rather than a bank, the P2P Lending platform ensures things stay simple by acting as an intermediary between parties. This means that, although the borrower is receiving a loan funded by many individuals, he/she won't ever need to contact them (both lenders and borrowers remain anonymous to each other), and all repayments are made through the platform.

  • P2P loans are unsecured and can be more flexible than conventional loans
    Because Peer-to-Peer loans are unsecured, there is no need to provide any collateral, so borrower won't need to tie any personal property to the deal, as is the case with many other types of borrowing. This also ensures that the application process remains quick and uncomplicated, allowing borrowers to access funds in a shorter period of time.

Risks of Peer-to-Peer (P2P) Lending

  • Money drag
    Once a loan has been paid off by the borrower, lender will most likely have to re-invest the loan amount and the interest he/she have received into a new loan. Most people use the auto-invest option that many P2P lending platforms provide for this.

    If the lending platform doesn't have enough loans matching to lenders loan criteria (e.g. interest rate, loan term), then he/she will be at a risk of having money on the account that doesn't generate a return. While it is not a disaster, it is definitely not suitable to have money invested at 0% return.

  • Borrower default
    Just as lending money to a friend, there's a risk the borrower might not be able to pay back the loan. This is called defaulting. If this happens, lender might have already received nothing or part of the loan back with no or some interest. Some P2P Lending platforms try to recover lenders money through various legal procedures, but he/she does risk losing the money.

  • Loan originator bankruptcy
    Some P2P lending platforms offer personal or small business loans from different loan originators (e.g. other companies like NBFCs, Service providers facilitating the loan process with the borrowers) while some platforms only offer loans, they have evaluated themselves.

    If lender use a platform that doesn't use third-party loan originators, loan originator bankruptcy is equal to the next risk: platform bankruptcy. However, if there's multiple loan originators on a site, there's a risk one of them might default. If they default, lender can lose his/her investment too.

  • Lender himself
    Lender are himself becomes biggest risk when it comes to his/her investments. Investors who want to boost their returns to a level higher than what is recommended by platform, invest in higher interest loans/borrowers.

How Safe Is P2P Lending?

P2P Lending platforms are legal, and the Reserve Bank of India (RBI) has categorised them as NBFC-P2P through a notification in August 2017. In October 2017, the RBI issued regulations for Peer-to-Peer (P2P) Lending. All Peer-to-Peer (P2P) Lending platforms are regulated by the RBI just like banks and NBFCs, so investing / lending through these platforms is legal business.

The Reserve Bank of India (RBI) has put a cap on the amount that can be borrowed and lent. The aggregate exposure of a lender or the maximum that one may borrow at any point of time, across all P2P Lending platforms, shall be capped at Rs 50 lakh. Even the exposure of a single lender to the same borrower, across all P2Ps, shall not exceed Rs 50,000 and the maturity of the loans shall not exceed 36 months.

How is Peer-to-Peer (P2P) Lending taxed

The first and foremost thing that lender need to know is that every EMI that he/she gets from a borrower has two components: principal and interest. Only the interest part is taxable. The principal part is not taxable. The interest income earned from P2P loans must be mentioned while filing tax returns under Section 56(2) of the Income Tax Act under "Income from other sources" under the column B3 in ITR1 and tax has to be paid according to the slab the lender would fall under. Currently, a lender cannot classify the P2P earnings as capital gains/loss.

Paying the applicable tax on income earned (through EMIs) is the responsibility of the lender and that it is left to the individual lender to declare their earnings. Currently banks deduct TDS on interest income from fixed deposits when interest from one FD or sum of all FDs with the bank is more than Rs 10,000 in a year. However, the same rule does not apply to P2P platforms, primarily because P2P platforms do not earn from the EMIs.

Peer-to-Peer (P2P) Lending Vs Crowdfunding

Both crowdfunding and Peer-to-Peer Lending are alternative finance modes for organisations to raise capital. While both are collective ways of raising funds, there are numerous differences in the way they operate, and the potential risks involved.

Crowdfunding is a method of raising finance which is typically suited to start-ups or early stage businesses, as borrower does not require to make regular repayments like one would with a bank loan. Instead, borrower can give away equity in his/her business or donate the final product.

P2P business lending is a fast and accessible way of getting a capital injection in business. The essential difference between P2P lending and crowdfunding is that borrower does not give away any equity, but rather pay interest on the money he/she borrow - much like one would with a bank loan. P2P loans are thought to be better suited to established businesses who can service their monthly loan repayments.

Peer-to-Peer (P2P) Lending Vs Mutual Funds

A Peer-to-Peer (P2P) Lending marketplace provides lenders with several borrowers to choose from. As a lender, one can go through the credit details of each borrower and decide which one to choose from.

This breaks down the scope of partial victory and makes this lending a win-win situation for both borrowers and lenders. This concept has been able to secure the trust of both parties equally. Plus, the advent of online Peer-to-Peer (P2P) Lending platforms has made the whole procedure transparent, which makes it easier for people to invest.

Investing in mutual funds involves pooling investor capital with a group of investors. A portfolio manager takes care of the money to be invested in various avenues. Mutual funds aim to reduce risks that are linked with stock market investments.

A mutual fund investment also provides an investor with mostly of options to invest in, such as equities, emerging market equities etc. All the holdings of a portfolio can be maintained and tracked upon easily which is an extra benefit associated with mutual funds investment.

The returns are not fluctuating in the case of P2P lending. Once lender lend his/her money to a borrower for a fixed duration, lender is entitled to get a fixed amount of interest as a return on his/her investment. Mutual Funds are subject to market risks. The return on a mutual fund investment is hard to compute because it fluctuates frequently.

Peer-to-Peer (P2P) Lending Vs Stocks

Leading P2P Lending platforms have the advantage of a wide array of borrowers of different income classes and backgrounds that allow investors to diversify their investments across various interest rate categories, reducing the risk of loan default efficiently.

In stock market, investors capital is usually managed by a stockbroker or a portfolio manager who in turn decides how much money is to be invested and where. The stock market is a much more volatile investment option - depending on various external factors which investors do not have direct control over, when compared to Peer-to-Peer (P2P) Lending, it is far less transparent and democratic.

Peer-to-Peer (P2P) Lending returns that the lender gets can be entirely chosen by him/her depending on the risk appetite. Whenever a lender lends money to a borrower for a fixed duration of time, he/she gets back the return in the form of interest on the total investment.

Stock market returns depend heavily on the market. It depends on market risks and is thus very volatile. The return that an investor gets varies heavily and is not at all predetermined. When the market condition is good the investor can expect to get a good amount of return but when the market condition is down the rate of return also becomes low.

Peer-to-Peer (P2P) Lending Vs Personal Loans

The primary difference between a personal loan and a peer-to-peer loan is who will grant the loan to the borrower. If the money comes from a lender who is an individual on an online platform, then it's a Peer-to-Peer loan. If the money comes from a bank or another financial institution (NBFC) then it's a personal loan.

Bank loans often come in the form of a personal loan. Customers who are in good standing and have good credit may benefit from a bank approve personal loan because of the competitive interest rates. The typical interest rates in comparing a peer-to-peer loan to a bank approved personal loan are very similar.

Peer-to-Peer loans have looser eligibility requirements, quick turn-around time for approval, and borrower may be able to get good terms if he/she has good credit. Even if borrowers have less than excellent credit, he/she may still be able to get a loan. With a bank approved personal loan, borrower get the stability of borrowing from a well-known institution and his/her rates and terms may be a bit lower, especially if borrowers have good credit.

Future of P2P Lending

India is the fastest growing economic hub in the world. Millennials today, as young as 21 years are focusing on living their lives to the fullest even if their means are limited. In order to meet these demands, people are looking out for money being available at their disposal almost instantly for which they are resorting to newer avenues of finance like Peer-to-Peer (P2P) Lending in India.

The P2P market is estimated to grow to around $20-25 billion by 2025. A major portion of the currently underserved market will be covered under the financial umbrella, all thanks to Peer-to-Peer (P2P) Lending platforms. People that are currently opting for banks to fulfil their financial needs, would migrate to Peer-to-Peer (P2P) Lending platforms as the P2P loan application processes are very efficient. This very trend has been spotted in countries like the UK and the US where P2P lending platforms have become preferable over banks. For the lenders on these Peer-to-Peer (P2P) Lending platforms, the returns are very lucrative which will continue to be the case along with more checks and processes introduced by Peer-to-Peer (P2P) Lending platforms in order to keep NPAs in check.

With RBI's support, the Peer-to-Peer (P2P) Lending industry is already moving to the next level of market adoption for lending money online. With all things going their side, Peer-to-Peer (P2P) Lending platforms are here to stay.


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