Pros & Cons of Peer-to-Peer Lending

It’s such a financial pickle when you can’t meet all your bank’s requirements for a loan. Is there another way to borrow money? In fact, there is – say hello to peer-to-peer lending! 

What started out in the UK in 2005 has become a prevalent tool in established financial markets around the world. Singapore is no stranger to it either. Peer-to-peer (P2P) lending is recognised by the Monetary Authority of Singapore (MAS) as a method of lending and borrowing money. 

Is it really a good option for borrowers? How risky can it be for a lender? Let’s find out by taking a look at the pros and cons of peer-to-peer lending.

What is peer-to-peer lending?

Essentially, P2P lending is a fintech tool that allows you to borrow money without having to go to a bank. It’s mostly used by small and medium-sized businesses or start-ups that find it difficult to get a bank loan. 

Here are the two main features of P2P lending: 

1. It serves as a platform for borrowers to find multiple sources of financing without providing collateral
2. It allows lenders a chance to loan their extra money and make a decent profit from returns

A P2P platform allows liaison between lenders and borrowers. It evaluates borrowers’ applications, and then posts the loan requests on the website or app. Then, lenders can review these applications and invest in their desired risk and return criteria. 

More often than not, a single loan is funded by multiple lenders. This allows lenders the chance to diversify their investments. This divides the risk among multiple lenders. 

While it is a lucrative option for many, everyone’s abilities vary. So, if you’re considering this option, it’s important to know the pros and cons of peer-to-peer lending as a borrower and a lender. 

Pros and cons of P2P Lending 

For borrowers

For lenders

Risks of P2P lending for borrowers

#1 Security

There is a cybersecurity risk, especially with the amount of information you need to share in order to get a loan. Given that P2P platforms are hosted by private companies online, we can't be too sure that there won’t be any security breaches in terms of documents shared or money transfers. 

#2 Interest rates

There is no fixed interest rate on every P2P platform. Interest rates are set depending on your credit rating and company history. Hence, you may run the risk of having a high rate of interest if your credit rating is low.

#3 Lack of investors

Sure, there may be far more P2P investors now than in 2005, but that means you have more competition as well.  With other loan applications on the platform, you may have a hard time attracting lenders.

You may not find enough investors to give you your desired loan amount. It would be risky to entirely depend on P2P for all of your funding. 

#4 Feud with lenders

In case you consistently default on repayments, then the right to extract the remaining loan amount lies with the lender/investor. 

Some P2P platforms shift bad debts to a debt collection agency, or at least suggest this option to lenders. However, there is no guarantee that lenders will necessarily follow this route. Thus, lenders may employ illegal or aggressive methods to regain the remaining loan amount. 

Risks of P2P lending for lenders

#1 Security

Lenders may also be victims of cybersecurity breaches. While P2P platforms are monitored by MAS, there are still fewer regulations in place compared to traditional banks. Therefore, the security of your funds and confidential information are more at risk with P2P platforms. 

#2 Repayment

Borrowers do not need to offer collateral to secure a loan. They may also have a lower credit score than what’s required by banks. Thus, there’s a higher risk of non-repayments. 

There’s very little regulation to ensure that borrowers repay the full loan amount. In addition to this, the loans would not be insured. Thus, lenders would have a hard time in case of default on payment.

#3 Liquidity 

The wait for the return of investment may be longer with P2P lending. The loan would be repaid in instalments, hence, you can’t retrieve a large sum until the loan matures. 

The interest will be your source of returns, which only materialises over time. Thus, a P2P investment is not something you should consider if you’re looking for a quick return of investment. 

#4 Loss of returns

Apart from potentially losing from repayment defaults, there’s also a chance that the borrower would repay the loan early since most P2P platforms offer flexible repayment terms.

If this happens, you could lose the additional interest you would’ve gained if the loan was active for a longer period of time. 

#5 Fraudulent applications

While a P2P platform vets the authenticity of every application, there is still a higher risk of fraudulent applications. 

The worst part? There is little to no security if you do happen to loan money to a fake applicant. So, be cautious and vigilant instead of completely relying on the P2P platform. 

Is P2P a good alternative to other loans?

P2P is a good alternative if you are a start-up or SME. It offers the opportunity to gain a source of credit when you don’t meet the traditional banks’ requirements. In addition to this, there is also the possibility of lower interest rates. 

On the other hand, you may gain more from a bank loan since there wouldn’t be a relationship between the P2P lender and the P2P borrower aside from fund transfers. Many banks offer valuable help to SMEs by assisting with their cash flow management and international transactions. 

There are certain benefits you can obtain only from a bank loan. On the other hand, it may be easier for you to obtain a P2P loan. Overall, it would be advisable to use P2P lending as a complimentary source of money, but it all boils down to your financial needs. 

Is P2P lending profitable?

If you choose your P2P lending platform carefully, you could really diversify your investments. A good platform will not only offer a secure space to invest in, but it will also have a variety of applications. 

Larger amounts of money can be loaned to established SMEs at higher interest rates, so there’s a better chance of repayment. 

On the other hand, if you don’t mind taking on a bigger risk, you may loan to new start-ups that require longer repayment periods. This way you can earn more in returns. However, you would have a higher risk of default on payments. 

In conclusion, P2P lending is a profitable avenue. While there may be risks involved, there are also opportunities for high return of investments. It’s worth a shot if you manage to pick a credible platform and application. 

Build your investment portfolio with knowledge and confidence. Follow our step-by-step beginner's guide to start now!

Get the free guide

Read these next: 
5 Risks of Investing in Peer-to-peer Lending 
6 Alternative Investments To Diversify Your Portfolio
7 Sources of Capital For Business Owners In Singapore
Starting Your Company In Singapore: A Guide To All The Costs
5 Key Reasons Why Successful SMEs Take Business Loans