P2P lending 101: What is it and how do you go about it?

Peer-to-peer lending can be an excellent way to leverage your savings or get a loan without a good credit score. Read on to find out how.

P2P lending 101: What is it and how do you go about it?

Peer-to-peer (P2P) lending has become a buzzword. A recent report suggests that the global P2P lending market touched USD 68 billion in 2019, up from an estimated USD 9 billion in 2014. In India, over 30 P2P companies received licenses to lend in 2016.  

Faircent.com, a prominent P2P lender, has seen its revenues grow by five times in 2018. Recently, the RBI classified P2P lending companies as NBFCs (Non-Banking Financial Companies). This is expected to bring in greater compliance and might well result in a P2P lending boom.

If you don’t want to miss the party, it’s important to figure out what is P2P lending and how does peer to peer lending work. Read on for a list of things to know before you part with your money in the booming P2P space.  

What is P2P lending?

P2P is a marketplace for borrowing and lending money. It is analogous to Flipkart or Amazon. Instead of connecting sellers and buyers of retail products, it links potential borrowers and lenders with each other.  

How does peer to peer lending work?

In P2P lending, a borrower buys from the public or from individuals. The lender gives money to earn a good interest and profits from the system. 

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3. What are the rules for P2P lending?

Anyone above 18 years of age can lend money on a P2P network. They should have a valid PAN and a bank account. Any NBFC or companies listed under the Indian Companies Act can also lend. 

4. What are the benefits of P2P lending for borrowers?

The chief benefit for borrowers is that one can avail of a loan even if their credit score is not up to the mark. They can choose whom to borrow from, based on their needs, ability to repay, and the terms and conditions. 

Many types of lenders lend solely on the basis of credit score. And this is generally computed using your credit card repayment and loan repayment history. It does not give a full picture of credit-worthiness. However, P2P lending sites assess 40+ parameters like education, monthly income, and many other behavioural patterns. Based on these, borrowers are typically classified as A, B, C, D, E or F category, with A being the least risky and F being the riskiest. This makes the system more flexible. 

Another big benefit to the borrower is that much less time is needed for documentation and other details.

5. How much money can one make from P2P lending?

Lenders can earn higher interest on their money than if they were to keep it in a bank savings account. The average rate of interest is pegged at 12-28%, and some sites even fetch you returns as high as 48%.[S3] The rate of return is directly proportional to the risk profile of the borrower. The minimum lending can start at something like Rs 750 or even Rs 500. To allay lenders’ fear of the risk of defaults, the minimum cap is considerably lower compared to other systems.

Banks, on the other hand, give an average of 3-4% for money in a savings account, and 6-7% for money in a fixed deposit. 

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6.What to be on guard against?

One of the biggest misconceptions about P2P lending is that it’s the same as crowdfunding. While the two may look similar, their fundamental principles are different. Crowdfunding is when people donate money to a venture and hope to see it grow. There is no monetary benefit to the lender but goodwill and wanting to see the company or individual succeed. P2P lending, on the other hand, is a profit-making system. A person, NBFC, or company lends money to earn interest from the proceeds. There is no altruistic purpose to it.  

The most common question asked is, ‘is P2P lending safe in India?’. The risk of default will be very high in a P2P lending scene. Okay, the risk of default is always there in any lending scene, whether it is a typical bank or a moneylender or a P2P model. However, many regular lenders on P2P websites say that the average default rate is about 10%. Thus, if you invest Rs 10,000 at 40% interest with multiple borrowers, if the risk is 10%, even then you will get a 30% return on your investment.  

P2P platforms have a recovery mechanism in place and will levy a penalty in case of default. The loan is based on a legally enforceable contract and you can even sue the borrower in a court of law under Section 138 of the Negotiable Instruments Act.

7.What’s the best way to approach P2P lending? 

Start small or start tiny. Some firms allow you to lend as low as Rs 500. Understand the investment and all the risks involved. Learn the skills and tricks of the lending trade. Once you have understood the basics and figured out the do’s and don’ts, you can take the plunge.  

Diversify your investment over several borrowers. Make sure that the money you invest is spread over multiple borrowers. Don’t end up putting all your eggs in one basket. The RBI has capped a lender’s exposure to a single borrower at Rs 50,000 across all P2P platforms.

Now that you know about peer-to-peer lending, you might want to explore it further for either lending or borrowing, depending on your requirements. 

8.Does peer to peer lending affect credit score?

As it is an investment for the lender, there are no implications on the credit score. The borrower’s credit score will get impacted on a hard credit enquiry. Fulfilling the terms of the loan adequately can help improve a borrower’s credit score.

9.How is tax on peer to peer lending levied?

Only the interest income part of the EMI received from borrowers by the lenders is taxable. There isn’t any taxation on the principal component. 

There isn’t any definite taxation rate. The interest income is added to the total income of the lender. Therefore, it can be inferred that the interest income is taxed as per the income tax slab under which the lender falls.

Now that you know about peer-to-peer lending, you might want to explore it further for either lending or borrowing, depending on your requirements. 

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