In the last decade, an alternative to traditional lenders has emerged in peer-to-peer (P2P) lending. Here's a rundown on how lenders like Lending Club and Prosper work. Peer-to-peer lending services pair would-be borrowers with investors willing to issue loans. You can think of them as a financial counterpart to eBay, except that you, the borrower, will never deal directly with the investor; the P2P service handles all the transactions, from determining loan eligibility to setting rates and fees, to processing payments.
P2P lenders' main appeal for borrowers is lower interest rates than are typically available through traditional lenders like banks or credit unions. P2P lenders offer borrowers other advantages as well: Their application processes typically take only a few minutes, which makes it easy to shop around for the best deal. And for reasons we'll discuss below, that shopping process is gentler on your credit scores than applying for traditional loans. If you're thinking about a debt-consolidation loan, or if you need cash for home improvements or other expenses, P2P lending is definitely an option worth considering.
Shopping for loans
Shopping for a loan at a P2P provider is a two-step process. First, based on a credit score (or credit scores) and your answers to a few basic questions—your full name, address, date of birth and annual income—the lender determines which loan offer(s) to extend to you. (It's possible at this juncture that the lender will decide not to extend any loan offers; if they do, they'll explain why.)
Once you choose the loan you want, the lender does a more detailed credit check and may ask you to verify your income and to provide additional background information. Each P2P site has its own lending criteria, including minimum credit scores, and additional information requirements vary accordingly. Some P2P lenders want information on your educational background; others want work history or details about your financial assets. In most cases, you can submit the necessary documents electronically.
Once you've provided the required info, the site assesses it and finalizes the lending decision—a process that can take a few days to a week or more, depending on the loan amount and the lender's criteria. (Here, once again, the lender can decide not to issue you a loan; in that event, they'll explain why.) If the loan is a go, you set up a payment procedure—most P2P lenders prefer automatic electronic payments—and the loan amount can be in your bank account within a few days.
Potential credit impacts
The first step in the P2P loan-approval process gets one or more of your credit scores by a method known as a soft inquiry—the same process you use when you check your own credit scores. Soft inquiries have no impact on your credit scores. However, the hard inquiries traditional lenders make when you apply for a credit cards or bank loans are reported to the national credit bureaus. They appear on your credit reports, and typically cause temporary credit-score drops of several points.
In the second step of P2P loan approval, the lender performs a hard inquiry to confirm your credit score and, likely, to review your full credit report. That typically lowers your credit scores by a few points, and if you get final approval, your scores may drop a bit further still. Those score dips reflect the fact that taking on new debt can make it harder to repay loans. Most borrowers' credit scores bounce back after a few months of timely bill payments.
What it costs
Per the table below, the interest rates charged by P2P lenders span a wide range, with annual percentage rates (APRs) as low as 5.49% and as high as 35.89%. The rates you qualify for will depend on your credit scores, income and, possibly, other factors considered in the application process.
P2P lenders, like their traditional counterparts, often charge origination fees, which can range from 0.5% to 6% of the loan amount. Fee amounts vary by loan provider and depend in part on the size of the loan and on your credit history. Origination fees are added to the loan amount and are reflected in the APR associated with each loan offer. That's why APRs, and not the "base rate," is the best way to get apples-to-apples comparisons between loan offers.
None of the P2P lenders we looked at charge penalties for paying your loan off early, but some do charge penalties or servicing fees for late payments, failed automatic withdrawals, or bounced checks.
Before you apply for a P2P loan
- Take a look at the fine print on the bottom of each provider's homepage, to get an overview of the loan amounts they offer and the rates and fees they charge.
- Make sure the lender operates in your state. Several P2P lenders don't do business in every state; and some have limitations that apply on a state-by-state basis. That information is in the homepage fine print as well.
- Check your FICO® Score* and review your credit reports for any major negative entries. Accounts in collection, liens and civil judgments are among the items that could torpedo your loan application, even if you meet the credit-score requirements.
- Determine the amount of money you need and watch out for tempting upsells. If you qualify for a larger loan amount than the one you request, some P2P sites will encourage you to consider borrowing even more. If you can put the money to good use, there's nothing wrong with increasing the loan amount, but never forget you'll be paying for that additional cash.
- Consider using the Experian loan-referral tool to explore offers from multiple P2P lenders (and possibly traditional lenders as well). You'll need to follow up at the individual P2P sites if you decide to follow up on your application, but getting offers from multiple sources at once can make the process even quicker.
Each P2P lender is a little different, and the two-step approval process makes it easy to check them out without dinging your credit scores. If you find one that suits you, and personal loan or debt-consolidation is on your to-do list, a P2P lender could be a great vehicle for you.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on November 15, 2017, and has been updated.
*Credit score calculated based on FICO® Score 8 model. Your lender or insurer may use a different FICO® Score than FICO® Score 8, or another type of credit score altogether. Learn more.