Peer-to-Peer Lending Key Terms

Know what you're getting into with peer-to-peer lending

By Shannon Tani

Peer-to-peer lending is a popular option because it humanizes the money lending and borrowing experience. Rather than simply basing a decision on a credit score, in peer-to-peer lending, the borrowers are able to give more detail about why they want the money, which means that loans are also based on personal character. Interest rates are often attractive to both lenders and borrowers, and social lending sites also allow lenders to participate in microfinancing.

Social lending

Social lending is another way to say peer-to-peer lending. It's a way for regular people to borrow month from other people, rather than through a bank or lending institution. Lenders get a return on their money, which is often higher than other types of investments.
Try: Social Lending Network talks about social lending and shows a pie chart that breaks down the reasons that people take out loans through peer-to-peer lending.

Microfinance

Microfinance is the lending of money to the poor. Typically, richer nations and people provide small loans to poor people in third world countries. The amount of money is small by first world standards, but it helps the person to start a business to earn a regular income. Interest rates for lenders are either low or non-existent, but it's a way to use your money to make a distinct difference in someone's life.
Try: Kiva specializes in peer-to-peer microfinancing and has a good explanation on their site.

Interest rate

The interest rate is the additional amount that must be repaid with the loan. This varies depending on an individual's credit score. However, in peer-to-peer lending, the interest rates for the borrower are often much lower than the rates they would get from a bank. For lenders, the interest that they receive on their money is typically higher than what they would receive through alternative investments. It's a win-win situation.
Try: Lending Club, a peer-to-peer gateway, describes interest rates and how they determine the interest rate that a borrower receives.

Family mortgage

Most mortgages are too large to get a peer-to-peer loan. However, if a family member wants to loan money for a mortgage, some peer-to-peer companies can set this up to ensure regular collection of money. This is called a family mortgage, and gives the lender the opportunity to help their family and the borrower often gets a much lower interest rate than what they'd get through a traditional mortgage.
Try: Virgin Money facilitates family mortgages and explains what they are on their website.

Credit grade

A person's credit report contains personal information that they may not want to share with the world. Credit grades are a way for peer to peer lending companies to rate borrowers, giving lenders an idea of how risky the investment is. Those with good credit may receive a credit grade of A, while someone with bad credit may receive a C or D.
Try: Prosper describes how the credit grades they give match up with credit scores.

Diversification

When investing money, it's important to diversify your investments to prevent significant losses. Similarly, with peer-to-peer investing, you want to diversify funds over several different borrowers. That way, if one person defaults on a loan, you do not lose all of your money.
Try: FinAid Page includes details on diversification under the section "Advice for Lenders."