Peer-to-Peer (P2P) Lending: How It Works & Its Benefits

Traditionally, money lending has been reserved for banks, financial institutions, and professional money lenders. Earlier, people borrowed money from their family and friends, but that sector was never organised.Peer-to-peer lending has emerged as a midway between these lending options. You can borrow money without a bank or a lender in the middle, but at the same time, the loan would be regulated and organised.

• P2P loans are offered by an individual having excess funds to a borrower. A P2P platform connects lenders and borrowers through their website.
• P2P loans are regulated by the Reserve Bank of India (RBI). They must observe several regulatory requirements to conduct their business in India.
• b are beneficial for borrowers who are not eligible to borrow money through traditional channels. They also provide an investment opportunity to investors looking to earn a higher return on their money.
• However, P2P loans have several risks such as the risk of default and the lack of a strong regulatory framework.

Under peer-to-peer lending, individuals who have excess funds lend their money to those who are looking for unsecured loans . These people are not professional lenders, they are people looking for a unique investment opportunity. This transaction is done without any bank or financial institution in the middle. It is often preferred by those who cannot get a loan from traditional methods due to strict eligibility requirements.

Peer-to-peer loans involve three parties- a borrower, a lender, and a P2P loan platform. A P2P platform is a website that connects investors with potential borrowers and facilitates the transactions between them.Those who wish to earn some money by lending excess funds can sign up on these platforms as a lender. Similarly, individuals looking for an unsecured P2P loan can apply for a loan through the platform. Once an investor is matched with a loan applicant, the investor provides the loan money and the borrower has to pay it back with interest. The P2P platform charges a small commission of 1-3% for its services. Also Read: 4 Reasons Why You Should Apply for a Personal Loan

The Reserve Bank of India (RBI) regulates P2P lending in India. In 2016, RBI released a consultation paper on P2P loans to provide a framework for peer-to-peer lending in India. RBI has chalked out various rules for this lending method, such as

• P2P platforms must obtain a Certificate of Registration from the RBI.
• The platforms must have a minimum capital of ₹2 crore.
• The P2P platform will be involved as only an intermediary. It will not show the loans on its balance sheet.
• The platform can give an opinion about the creditworthiness of the borrower and the suitability of the lender.
• P2P platforms cannot assure the lenders of any return.
• The platforms must set up a risk management framework including an alternative arrangement to complete the transactions in case of the platform's failure.
• The platforms must submit a report on their financial transactions to the RBI.

Also Read: How to Choose the Right Personal Loan Lender or Loan Provider?

Here are some of the main reasons why P2P loans can be beneficial for lenders and borrowers:

• Access to credit P2P lending provides access to credit to those who are not eligible for getting a loan from banks and financial institutions. For example, if you have a low credit score.
• Investment opportunity P2P loans allow the investors to earn a good return on their excess funds. While banks provide a return of 6-7% on fixed deposits , P2P lending allows you to earn 10-12% interest on your funds.
• Streamlined process The online platforms make the P2P lending process streamlined and convenient for both parties.

Every investment opportunity has a risk attached to it. Here are the potential risks you must consider before being a part of peer-to-peer lending.

• The risk of default .Investing in P2P loans can be risky because the borrower may not repay your loan on time or not pay at all. You must assess the creditworthiness of every borrower using the information on the P2P platform before lending them money
• Fraudulent activities .You may fall victim to fraudulent activities on P2P platforms such as fraudsters pretending to be lenders or borrowers.
• Limited regulatory protection Although RBI regulates P2P loans, the regulatory framework is not as strong as banks or financial institutions. You get limited protection from the law as a consumer.

Your earnings from P2P lending depend on the interest rate and the duration of the loan. The interest rates on P2P loans are based on the creditworthiness of the borrower. For instance, borrowers with poor credit scores are ready to pay higher interest rates on loans and vice versa. If you wish to earn higher returns, you must be willing to take more risk. Generally, you can earn 10-12% on these loans.

When you earn money through P2P loans, you may need to pay taxes on it. Here's a summary of various tax provisions regarding P2P loans in India.

You can invest in P2P lending if-

• You have extra savings after allocating money for emergency fund, insurance, safe investments, etc.
• You are familiar with how P2P loan platforms work.
• You understand the risks associated with peer-to-peer lending including the risk of loan default.

Peer-to-peer lending is gaining popularity in India among investors as well as borrowers. These loans allow an opportunity to earn a higher interest to investors. They also allow borrowers to get access to credit without the burden of strict eligibility requirements set by banks and financial institutions. However, both lenders and borrowers must be aware of the risks associated with online peer-to-peer lending before investing or borrowing money through these platforms.