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Peer-to-peer lending: What you need to know

Here are the basics of how peer-to-peer lending works.

Video Transcript

- If the idea of total strangers lending you money outside of the traditional bank setting strikes you as strange, it's really not. It's a form of business called peer-to-peer lending, also known as person-to-person lending, peer lending, P2P, or social lending.

P2P is the lending of money that occurs directly between parties without the involvement of a traditional financial institution. It actually dates back centuries and is rather common. Its modern form was made possible by the internet, and it has evolved to become a business activity of its own with a profit motive. The typical amount of money borrowed varies greatly, but most loans are small. The lack of a middleman means that there is lower overhead than would be with a traditional financial institution.

Many of the pros and cons of P2P arise from its directness and its lack of an intermediary. It's attractive to those with poor credit, considering some would-be borrowers don't qualify for traditional loans because of their poor or nonexistent credit. There's faster turnaround in getting a loan approved and money transferred because of less red tape. As far as the cons, defaults are high because P2P attracts borrowers with low credit. And because low credit is correlated with defaults, there is the risk of default to consider. There are also fewer services and insufficient information about borrowing requests. Insufficient regulation can open up to loansharking because P2P is less regulated than traditional institutions.

Stay financially fit, friends.