Here's What to Know About Peer-to-Peer Lending

Sometimes, people need to borrow money for personal or business expenses and a traditional bank loan is not an option. Enter the idea of peer-to-peer (P2P) lending: "Peer-to-peer lending is a form of online lending that facilitates a direct connection between individual investors and people or businesses that are in need of a loan," explains Jill Gonzalez, senior analyst at WalletHub. "P2P lending can be a better option than banks when borrowers don't have great credit, or they don't qualify for a personal loan. The P2P funding process is also a lot quicker than that from a bank or credit union."

As is true with any other loan, you do need to understand the application process and the terms of the loan. According to Gonzalez, here's what to know before you sign your name on the dotted line.

The Application Process

"If you want to borrow money via peer-to-peer lending, the process is fairly simple. You start by filling out an application, which may also include a credit check. Then, you can review your potential interest rate, and decide if you want to move forward," explains Gonzalez. "If so, the next stage is funding, which means that your loan gets listed on the platform. If your loan is successfully funded, you move to the repayment stage, which means you'll make regular payments over the life of the loan."

The most well-known sites to apply for peer-to-peer loans include Prosper (for those with great credit scores), Payoff (if you want to pay off credit card debt), LendingClub (if you have an average credit score), and Funding Circle or Kiva (for entrepreneurs and small businesses). Each lending platform has different requirements from how you can use the money to the terms that you will have for paying it back over time. Most of them will require a credit check but a lower credit score doesn't mean that you won't get approved. "There aren't too many things required from borrowers in order to be approved for a P2P loan. The application is similar to that of a traditional unsecured personal loan, so borrowers will definitely need to have a source of income that will allow them to repay the loan," Gonzalez adds. "A big difference however, is the fact that you can get approved even with a lower credit score or little credit history."

Understanding P2P Loan Terms

Like with any loan, you will want to read over the terms, understand any fees you may have to pay, know your interest rate, and make sure that you can afford to make the monthly payments. "Before applying, they should also know that they will most likely have to pay an upfront fee, that is typically a certain percentage of the amount they need to borrow," says Gonzalez. Defaulting on these loans can and will be reported to the credit bureaus, so missed payments or non-payment can hurt your credit score. On the other hand, staying on top of the loan and making all of your payments on time can help to improve your credit score.