If you are considering an investment in P2P lending, one of the most important decision you must make is selecting the right lending platform. Many investors who are new to P2P lending assume that all platforms are basically the same. This is not true. Generally speaking, P2P platforms can be divided based upon classification.
P2P Lending Companies can be classified by:
- Business Model
- Borrower Type
- Loan Use
- Type of Collateral
1. Business Model
P2P platforms operate under four different business models. The list includes: traditional P2P lending, P2P lending with loan originators, bank-funded P2P lending or balance sheet lending. Let’s briefly review each business model.
- Traditional P2P lending is very straightforward. Only three parties are involved in each lending transaction: the borrower, the lender and the owner of the platform. The platform serves as the intermediary between the borrower and the lender. The intermediary is responsible for handling all administrative duties. In addition to serving as intermediary, the owner of the platform is also responsible for soliciting new borrowers. In order to remain profitable, it’s absolutely critical for the platform to maintain a steady stream of new borrowers for investors. The traditional model is certainly the most popular model among investors. Based on historical results, it’s also the most profitable model for the P2P owners because the owners are required to perform the majority of the work. Consequently, they do not have to share the fees collected from the borrower.
- P2P lending with a loan originator adds an extra layer to the transaction, which can often lead to confusion among the P2P lenders. The loan originator is typically a non-bank financial institution with the sole purpose of providing a steady stream of new borrowers to the P2P platform. Loan originators use marketing strategies to solicit new P2P loans. Of course, platform owners love working with loan originators because they provide new business. In exchange for bringing new customers, originators receive a small slice of the loan origination fee. This arrangement works great as long as the originator supplies the P2P platform with high quality borrowers who will repay the loans. The loan origination model is quite popular among platform owners because the burden of soliciting new borrowers is no longer the responsibility of the P2P owners.
- Bank-funded P2P lending involves the use of a traditional bank, where the bank acts as the originator of the loan. Bank-funded P2P lending is similar to traditional P2P lending. Why? Because in both cases, the platform matches borrowers and lenders. Based on the fact that the loan is originated by the bank, the borrower signs a promissory note with the bank. Immediately after the bank has originated the loan, it will sell the loan to the platform. Consequently, the borrower will make payments to the platform. The bank has been removed from the equation.
- Balance sheet lending closely resembles traditional bank lending. When a bank originates a loan, the loan is kept on the bank’s balance sheet as an asset.
Customer deposits are classified as liabilities. In the same way, P2P platforms involved with balance sheet lending will both originate the loan and keep it on the balance sheet. Of course, by keeping the loan on its balance sheet, the P2P platform assumes the credit risk. However, in exchange for the credit risk, the platform will profit from both the origination fees and the interest payments accruing on the loan.
2. Borrower Type
All P2P activity involves consumer lending or business lending. Consumer lending would involve anyone legally classified as a natural person. Business lending includes all legal entities. Examples of a legal entity include: corporation, sole proprietor, trust, limited liability company and non-profit organization.
3. Loan Use
P2P loans are used for many different purposes. A few examples include: real estate, invoice financing, agriculture, education, automobile purchase, travel, credit card consolidation, home improvement or medical expenses. P2P loans can be used for practically anything.
4. Type of Collateral
Peer-to-peer loans can be secured with collateral or unsecured without collateral. If the loan is secured with some type of collateral, the terms of the loan are much more favorable for the borrower. The most popular forms of collateral include: automobile, business inventory, business equipment, real estate, accounts receivable, stocks, precious metals and artwork.
As you can see, there are several different factors to consider when selecting a peer-to-peer platform. The best course of action is to select a platform with a solid reputation within the P2P industry. Check for customer reviews and talk with friends who have invested in P2P lending.
Do your research by reaching out to various platforms and asking questions. Take note of the customer service you receive when you contact each platform. How were you treated? Did the platform answer your questions in a timely manner? This is a great way to “interview” each platform before deciding where to invest your money. Find a platform that makes you feel comfortable.