The Power of Peer-to-Peer Lending

Peer-to-peer lending has attracted considerable attention in recent years, largely because it offers a novel way of connecting borrowers and lenders. But as with other innovative approaches to doing business, there is more to it than that. Some might wonder, for example, what makes peer-to-peer lending so different–or, perhaps, so much better–than working with a bank, or why has it become popular in many parts of the world.

Certainly, the industry has witnessed strong growth in recent years. According to Business Insider, transaction volumes in the U.S. and Europe, the world’s leading P2P markets, have expanded at double and, in some cases, triple-digit percentage rates, bolstered by widespread acceptance of doing business online and a supportive regulatory environment.

Two benefits in one

One obvious question, of course, is what is peer-to-peer lending? Generally speaking, it refers to an online marketplace where those seeking attractive returns can invest in loans to individuals and, increasingly, start-ups and existing companies. Powered by major advances in technology and the global reach of the Internet, today's most popular peer-to-peer lending sites represent a financial alternative that can benefit everyone involved.

For investors, "peer 2 peer lending," or "P2P," offers an attractive way to diversify portfolios and enhance long-term performance. When they invest through peer-to-peer lending platforms, they can profit from an asset class that has proven itself in both good times and bad. Equally important, they can avoid the risks associated with putting all their eggs in one basket, especially at a time when many experts believe that traditional favorites such as stocks and bonds are riskier than ever.

Enhancing your portfolio

Even if this was not the case, there is a lot to be said for the benefits of diversification. Academic researchers and investing professionals figured out long ago that one key to long-term investing success is to spread risk among various asset classes, including those that can generate regular income. Simply put, when you invest in peer-to-peer lending, you are not only exposed to an investment that has fared well over time, you also enhance the upside potential of your overall portfolio.

But the benefits don't just flow in one direction. For borrowers–who have tended to be individuals, though that is changing fast as businesses experience the benefits of P2P for themselves–online marketplaces have enabled them to obtain financing when they couldn’t do so through traditional channels. Because of increased regulation and risk aversion, banks and other intermediaries in many countries around the world have been unwilling or unable to lend to certain types of borrowers, even those considered creditworthy by most standards.

Investing for the long run

This is especially true with respect to near-prime borrowers, who have a good record of paying back their obligations on time. However, with bricks-and-mortar lenders being pressured to focus instead on the needs of top-tier clients–many of which probably don't need the money anyway–a less-than-perfect credit rating has not been enough to convince them of the merits of assisting borrowers in their own backyards. Under the circumstances, many have had little choice but to go elsewhere.

There are other reasons why borrowers and lenders can benefit from how peer-to-peer lending works. Instead of acting like traditional middleman and grabbing a sizable cut from all sides, online venues earn their keep through full transparency and an operating model designed with the interests of clients in mind. As with any business, they exist to make a profit, but they also understand that the financial world is an increasingly competitive arena, where solid long-term relationships represent the difference between success and failure.

A win-win relationship

Another reason why peer-to-peer lending works, especially in a region like Europe, where traditional operators have not been especially upfront about discussing costs or risks, is because it offers the kind of transparency that helps ensure a better experience for borrowers and investors alike. When both sides know what to expect and have all the details they need to make an informed decision, it reduces the uncertainty that can prevent them from striking a mutually beneficial deal.

Indeed, unlike with many traditional financing arrangements, it is common for borrowers and investors who participate in these online venues to view their transactions as "win-win." instead of walking away feeling like they paid too much or received too little in return for the risk they took, they understand that peer-to-peer lending sites enable them to work together in such a way that their interests are aligned.

Transparent and clear

Even in those difficult but predictable circumstances when borrowers fail to live up to their repayment obligations, the outcome is not an unwelcome surprise. With a firm like Bondora, for example, what happens next has been clearly laid out. Together with a well-managed default-control process, this helps ensure that when you invest in peer 2 peer lending, you are not taking the kinds of risks that seasoned investors seek to avoid. Instead, you are kept in the loop by a financial partner that has little to gain from taking advantage of its clients.

As with any industry, there are differences between the various peer-to-peer lending sites. It is important to consider technological and underwriting capabilities, customer service and support, and flexibility and ease of use, as well as other factors that can make the difference between a poor relationship and one that is made to last. Regardless of whether you are a borrower or a lender, an individual or business, or are large or small, it makes sense to know just what you are getting into.

With all of that in mind, one thing seems clear. For those who are seeking an attractive investment alternative, P2P lending is an ideal place to start.