Overview
Most peer-to-peer loans are unsecured personal loans, i.e. they are made to an individual rather than a company and borrowers do not provide collateral as a protection to the lender against default. Business loans are offered by some companies.
The interest rates are set either by lenders who compete for the lowest rate on the reverse auction model, or are fixed by the intermediary company on the basis of their analysis of the borrower's credit. Borrowers assessed as having a higher risk of default are assigned higher rates. Lenders mitigate the risk that borrowers will not pay back the money they received by choosing which borrowers to lend to and by diversifying their investments among different borrowers. Lenders' investment in the loan is not protected by any government guarantee. Bankruptcy of the peer-to-peer lending company that facilitated the loan may also put the lenders’ investment at risk.
The lending intermediaries are for-profit businesses; they generate revenue by collecting a one-time fee on funded loans from borrowers and assessing a loan servicing fee to investors, either a fixed amount annually or a percentage of the loan amount.
Because many of the services are automated, the intermediary companies can operate with lower overhead and provide the service cheaper than traditional financial institutions, so that borrowers may be able to borrow money at lower interest rates and lenders earn higher returns.
Read more about this topic: Person-to-person Lending