Borrowing Money Without Banks — An analysis of P2P lending vs. traditional methods
People have been seizing new opportunities recently to receive financing for their wide range of needs thanks to the developing technology. As one of the most significant innovations in the technology age, the peer-to-peer (P2P) platforms have emerged from an unreliable financial environment triggered by 2008 financial crisis. They started enabling individuals and small businesses to borrow without any traditional financial institution. As banking sector kept losing reputation, new “destructive” technologies such as blockchain technology supported the gradual elimination of traditional third parties from the transaction process between lenders and borrowers.
Another function of the P2P, as a marketplace for lending activities like any e-commerce websites such as Amazon, people are matched through online services according to their transactional approaches of either borrowing or lending. In parallel to the expansion of opportunities offered by the P2P system, most of the people are now able to get access to the credits that have not provided by traditional banks because of their “dodgy” credit scores. In that sense, it is possible to say that P2P platforms should be regarded more as complements to banks and they can improve financial inclusion by expanding access to credit for borrowers underserved by the banking system.
In traditional banking, lenders will want to review both the credit history of your business and, because a personal guarantee is often required for the small business loan, your personal history. Additionally, banks tend to lend to people with salary accounts, preferably working with grade-A companies. Thus, for example, it is more difficult to get loans for self-employed people at affordable rates.
As a new mechanism, in the P2P system, a loan decision is based on the proprietary scoring and pricing parameters providing a considerable amount of transactions into its fold. That is to say, P2P system is able to cater to even first-time borrowers or people who cannot withdraw a loan otherwise. “We are looking at credit-worthy people based on our proprietary assessment. It goes well beyond credit score and at times we could pick borrowers scoring high on multiple parameters despite not having high credit score and sometimes they could be first-time borrowers.” Says Amit More, the founder of Finzy.
As another backbone of the P2P system, the lenders can evaluate the eligibility of the potential borrowers to give a loan. The lenders can look at individual loan listings and see multiple parameters such as credit grade, income, DTI, occupation, location etc. Thus, the lenders can filter out unqualified borrowers according to their own strategies. Moreover, the system also provides borrowers with individual risk assessment, eligible lender search, lending combination and loan recommendation.
In recent years, P2P loaning systems created an impression of win-win situation for both lenders and borrowers. One of the main reasons behind this claim is related to the flexible interest rates of loan activity in this platform. There is an increasingly popularized idea about the P2P system that by cutting out the large spread, a bank takes when making a loan, the lender can get a higher interest rate, than he might in a savings account and the borrower may get a lower interest rate, than using his credit card. How can we explain the existence of flexible interest rate in P2P system?
In P2P system, the existence of multiple lenders and multiple borrowers make the loan process more dynamic and complex. The borrower can get the loan from different lenders at different loan rates. In this loan type, he/she meets higher rates or lower rates at one time. But these rates aren’t important at all because the borrower cares for mixed-rate only. It is same to lender. So, decentralized loan will reduce the risk for the lenders and the borrower needs to find the optimal lenders and get the ideal loan.
At this stage, we can look at the types of loans offered by both banks and the P2P system to have a more detailed understanding of their main differences. For banks, there are two types of loans: secured and unsecured. An unsecured loan is usually for smaller quantities. You can borrow a fixed amount and usually pay back for a consensus of up to five years. After signing the credit agreement, the interest is set.
Secondly, it is possible to pay a secured loan which is for a more significant amount like property over a fixed term and at a fixed interest rate. The main difference between these two types of loans is that you stand to lose your ‘asset’ if you fail to make repayments.
On the other hand, the P2P loans are not entirely different from traditional loans. Like traditional bank loans, it is possible to borrow a fixed amount of money over a fixed term at a fixed interest rate. However, this money transaction is realized not by a bank but through your peers. Since P2P lenders have very few overheads, they can cut off banks with lower interest rates and better terms.
To sum up, as can be seen from many facts, in the P2P system, an investor can get access to the more flexible loans with better rates. For example, a borrower can get access to saving interest through the P2P site, because of the chance to make overpayments or pay off the balance of the loan early. However, we can’t say the same for neither secured nor unsecured bank loans. In traditional banking system, even if you can settle the loan early, you may have to pay the penalty in the form of interest because of fixed payments.
Lastly, there may be some concerns amongst readers about the risks of P2P loans compared to the bank loans due to the lack of face-to-face interaction during the lending process. However, it should always be remembered that all investments face a risk. Additionally, thanks to the diversified and decentralized portfolio of loans, P2P lending includes lower risk compared to the equity or commodity market investments or real estate.
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Sources
1- https://economictimes.indiatimes.com/wealth/borrow/are-p2p-lending-platforms-safe-for-lending-and-borrowing-find-out/articleshow/61654162.cms
2- https://www.p2p-banking.com/process-p2p-lending-how-are-interest-rates-set/
3- http://www.cafr-sif.com/2018/2018selected/85.%20Peer-to-Peer%20Lenders%20versus%20Banks_%20Substitutes%20or%20Complements.pdf
4- http://www.kristymlopez.com/2017/02/peer-to-peer-lending-vs-bank-loans-a-look-at-the-main-differences/
5- https://pdfs.semanticscholar.org/64d3/a854957f63d9d36257ad5dd56a2e974e393a.pdf
6- https://economictimes.indiatimes.com/wealth/p2p/got-poor-or-no-credit-score-here-is-how-p2p-loans-can-help/articleshow/65656296.cms
