Personal loans can be difficult to obtain through traditional channels, such as your local bank or credit union. In fact, as the economic crisis has deepened, it has become harder and harder to secure a personal loan through those institutions, and interest rates have climbed higher and higher. Many potential borrowers are also reluctant to borrow from friends and family members, as the loan usually puts a strain on the relationship. So if personal loans aren’t available from banks or from family members, how can you obtain one?
Peer-to-peer lending, also known as person-to-person lending or social lending, has recently gained popularity due to the very circumstances that make personal loans so difficult to get through normal channels. This type of lending offers the third-party neutrality of a banking institution with the less formal requirements and restrictions on lending that you might have gotten with a family loan.
How Peer-to-Peer Lending Works
Peer-to-peer lending has two common models: marketplace and family and friend. The difference between the two models is thus:
Marketplace lending–a potential borrower logs onto a website and applies for a loan; the lender who is willing to give the lowest rate of interest “wins” the loan. This is akin to the “auction-style” of other well-known marketplaces such as eBay, but in this case, the loan is the good being sold.
Family and friend lending–in this model, borrowers connect with family and friends who know each other already. The lenders pool together to finance the loan, formalizing the process of a typical personal loan between friends or family members.
In both cases, the lender and borrower benefit from the ability to formalize the transaction. It also allows borrowers who might otherwise be overlooked by traditional institutions to secure a personal line of credit. On the other hand, there is the potential for fraud on both sides, if neither party is careful.
Two Types of Personal Loans
There are 2 types of personal loans that one can obtain through peer-to-peer lending:
Secured line of credit–in which a borrower pledges collateral against the value of the loan. If the borrower defaults on the loan, the lender can then claim ownership of the collateral to offset his lost cash investment.
Unsecured line of credit–in which a borrower does not have to pledge anything against the value of the loan. Since this poses a greater risk to the lender, interest rates on unsecured loans are generally higher than on secured loans.