peer-to-peer lending

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

August 24, 2022 • 1459 views

If you need a loan, the first option that will come to your mind is to go to a bank or an NBFC. Yes, these are surely valid options, but today, borrowers have options beyond the conventional banking system. 
One such option is peer-to-peer (P2P) loans, where you get the option to borrow money directly from investors or lenders on platforms. You may get loans at surprisingly low rates and with an easy application process. 
Let us look at what peer-to-peer lending is all about:

What is a Peer-to-Peer Loan?

Sometimes, you are not eligible for a loan from banks and NBFCs because your income is low, you have a low credit score, the paperwork is improper, or the interest rate is high. 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.

Also Read: Everything You Should Know about Business Loan in India

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.

Key facts to keep in mind when using a P2P lending platform

  • 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 ?50 Lakh across these platforms at any given point. Further, a lender’s exposure to the same borrower cannot exceed ?50,000 across all P2Ps.
  • As a borrower, you are not allowed to borrow a total of more than ?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. However, 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. 

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. 
But, before you move on to P2P lending, if you need a loan, Poonawalla Fincorp offers a customized suite of quick, transparent, and hassle-free loan offerings. You can avail of a variety of loans such as Personal Loans, Business Loans, and so on. Get in touch today!

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