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What is Peer-to-Peer Lending?

Peer-to-peer lending (also known as peer-to-peer investing or social lending, and abbreviated as P2P lending) is a financial transaction related primarily to lending and borrowing, though it can include other more complicated transactions. P2P lending occurs directly between individuals or "peers" without the involvement of a traditional bank or financial institution. Unlike person-to-person charities or microlending, P2P lending is a for-profit venture and does not specifically have a philanthropic purpose.

P2P lending grew in frequency due to the ease of connecting borrowers with lenders via the Internet, and sites such as Prosper.com  and LendingClub.com  have become popular. The financial crisis that began in 2007 also made it difficult for some people to obtain traditional credit from banks and lenders, contributing to the rise in this type of lending.

With P2P lending, borrowers can usually find a better interest rate than a traditional bank can offer, and lenders may see a higher rate of return. These mutual benefits are the result of the lack of high overheads that traditional financial institutions have. In addition, person-to-person lending can be faster because individuals don't have to deal with the same corporate red tape and procedures that financial institutions do.

But there are important risks to P2P lending. New studies indicate that default rates on these loans may be much higher than initially reported, and returns may be less than advertised. While some sites do attempt to evaluate the risk associated with each borrower on a rating scale, average individuals may not possess the necessary financial background to properly manage the risks associated with lending.

Whether you’re using a P2P lending service or you’re borrowing or lending money between friends or family, make sure you draft a formal lending agreement with all the terms for the loan and repayment.