How Peer-To-Peer Loans Work? Know All About P2P Lending

Peer-to-peer lending or a P2P loan is a direct form of financing where businesses or individuals receive financial aid without any official institution’s involvement. Although P2P loans cover both secured and unsecured loans, most of them are unsecured Personal Loan agreements. In this blog, you will learn about them in detail and find out why they are preferred over alternative loan offers under specific cases. Read on!

What is a Peer-to-Peer Loan?

Sometimes, you are not eligible for a loan from banks and NBFCs due to various reasons such as low income, low credit score, improper paperwork, etc. In such a situation, you can opt for peer-to-peer lending.

Peer-to-peer lending takes banks and NBFCs out of the loan process and allows individuals and businesses to borrow money from investors. P2P lending enables you to get a loan to finance education, expand a business, refinance debt, etc. at a faster pace. In fact, in many cases, you can even receive funds in less than a week.

How Does P2P Lending Work?

Peer-to-peer lending typically happens over platforms that connect borrowers and lenders directly. If one wants to lend money to individuals and businesses, one can register on a peer-to-peer lending platform as a lender. If you are looking to borrow P2P loans, you can register on such platforms as a borrower.

P2P platforms evaluate you as a borrower on multiple parameters. Such portals do not limit their evaluation to only your credit score but check your income, credit history, employment status, etc. To enable this, peer-to-peer lending platforms make extensive use of technology. They may capture your credit or spending habits through app usage, social media activities, etc. Based on this alternative form of evaluation, your creditworthiness is decided by the platform.

If you are eligible for borrowing, you are assigned to a risk bucket. Based on your risk bucket, an appropriate interest rate is decided for you. If you are in a lower-risk bucket (the platform believes that you will not default), you are offered a loan at a lower interest rate. However, if you fall into a higher risk bucket, the interest rate you need to pay will be higher.

If you intend to lend money, you will be able to see various borrower options on the peer-to-peer lending platform. You can pick one or more borrowers based on the risk you want to take. If you prefer a higher interest rate on the sum you lend, you can lend the money to high-risk borrowers, and vice versa.

You may be wondering how the P2P platform profits from its operations. Most peer-to-peer lending platforms charge a fee from both the lender and the borrower for using the platform. It must be noted that P2P platforms are RBI-regulated, which ensures that your money is not held by the P2P platform.

Benefits of Peer-to-Peer Loan

These are several proven advantages of P2P lending:

• Comparatively lower interest rates for eligible candidates
• Flexible repayment plans
• Relatively faster approval process
• Easy eligibility criteria
• A great way to diversify your credit portfolio

Understanding the Risk Associated with a P2P Loan

There is risk associated with most investment options and this applies to P2P lending as well. The major risk with peer-to-peer lending is the default risk by the borrower. That is, the borrower may fail to pay the principal amount and the interest applicable on the loan. In this case, the lender stands to lose the entire sum lent.

This risk can be managed by evaluating the risk profile of the borrower well. The P2P platform typically has its evaluation process. However, if the lending platform’s technology is obsolete, it cannot correctly gauge the borrowers' repayment capacity, which may land lenders in a soup. In such cases, the lender may end up taking more risks than desired. Therefore, it is very important to spend enough time in finding the best peer-to-peer lending platforms.

Also Read: Effect of Inflation on Borrowers and How to Manage It

Key Facts to Keep in Mind When Using a P2P Lending Platform

These are some vital factors that each borrower and lender must be aware of:

• The interest rate ranges from 10% to 28%, and the tenure may range from 3 months to 36 months.
• All P2P platforms are regulated by the RBI. P2P platforms need to register for an NBFC-P2P license to provide these services.
• A lender cannot place a total of more than Rs. 50 Lakh across these platforms at any given point. Further, a lender’s exposure to the same borrower cannot exceed Rs. 50,000 across all P2Ps.
• As a borrower, you are not allowed to borrow a total of more than Rs. 10 Lakh across all P2P platforms.
• If a borrower defaults, P2P platforms do not guarantee principal or interest repayment. However, they may assist in recovery and filing a legal notice against the borrower even though it does not ensure a positive outcome.

Taxation: P2P Loans

In the P2P loan process, a lender’s earnings comprise the interest earned on the loan amount.

This interest earned from P2P lending comes under 'Income from Other Sources' in accounting terms. It will be added to your income and taxed as per your tax bracket. If you fall under the 20% tax bracket, you will have to pay a 20% tax on the interest earned.

Also Read: How to Check Active Loans Using Your PAN Card: A Step-By-Step Guide

Should You opt for Peer-to-peer Lending?

If you have been investing in fixed deposits, where you get 5–6% returns in the present scenario, an opportunity to earn more than 10% return may look attractive with P2P lending. However, P2P lending comes with a risk of losing the principal amount in the worst-case scenario. For the same reason, most investors consider it riskier than equity investments. You can use this option to invest a portion of your capital in high-risk investments for diversification. As a borrower, P2P loans can be a good option if you are unable to get loans from conventional sources.

To Conclude

Before you move on to P2P lending, to meet your urgent monetary needs, consider contacting Poonawalla Fincorp. You will get a customised suite of quick, transparent, and hassle-free loan offers. Avail of a variety of loans such as Personal Loan, Business Loan, and so on. Get in touch today!

Frequently Asked Questions

• What is a P2P lending company?

P2P lending companies are online platforms that help connect borrowers to lenders directly. It allows borrowers to get a P2P loan without having to apply for financing through a bank or non-banking financial companies (NBFCs).

• Are there any disadvantages of P2P lending?

Generally, the risk of default is greater and also the borrowing capacity is capped in most cases. Plus, some platforms can be unregulated leading to confusion later on.

• Which P2P platform is RBI-approved?

There are many P2P loan platforms that work without the involvement of institutional intermediaries such as LenDenClub, LiquiLoans, etc. You can register as a lender and earn even more interest returns compared to FDs.

Disclaimer

We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Loan disbursal is at the sole discretion of Poonawalla Fincorp.
*Terms and Conditions apply