Know Before You Borrow: 7 Questions Before Considering Peer-to-Peer Lending

By Alert Investor Markets Fool.com

If you needed to borrow money to make home improvements or consolidate credit card debt, where would you turn? For an increasing number of consumers, the answer is peer-to-peer lending platforms -- websites that match borrowers with investors.

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Peer-to-peer or P2P platforms issued $5.5 billion in loans in 2014, and that number is projected to grow to at least $150 billion by 2025, according to areportby Pricewaterhouse Coopers.

At least some of the industry's growth thus far, experts say, is due the ease and speed of the loan application and approval process.

"Consumers are hungry for a simplified, streamlined lending process, and peer-to-peer companies are capitalizing on this need," the PwC report said.

But just because an industry is growing doesn't mean you should rush to jump on the bandwagon. Before you apply for a P2P loan, make sure you read up onhow the platforms work, and consider these important questions.

Image source: Getty Images.

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Am I eligible?

One thing that makes some borrowers gravitate to P2P lending is the fact that P2P platforms tend to be more forgiving than banks when it comes to short credit histories. While the latter often deny loan applications from consumers who haven't borrowed in the past, P2P lenders often use more than just credit histories to determine a borrower's eligibility and creditworthiness.

Some platforms will consider your employment or even what you scored on your SATs, according to research by theFederal Reserve Bank of Cleveland. Despite the broader eligibility criteria employed by P2P platforms, they are similar to more traditional lenders in at least one key way: They may turn away borrowers with very low credit scores.

What interest rate can I expect?

Another reason borrowers may be drawn to P2P loans is the attractive interest rates offered by P2P platforms. Borrowers who apply for P2P loans may be offered rates that are lower than those charged by their credit cards, but that's no guarantee.

Interest rates vary depending on the creditworthiness of the borrower as assessed by the P2P platform. And while P2P platforms use some unconventional methods for assessing creditworthiness (see above), they also rely on consumers'credit scores. Those with the highest scores tend to get lower interest rate offers, while those with lower scores will typically be stuck with higher interest rates, if they are approved for loans at all.

Loans are often assigned a letter grade, with "A" loans having the lowest probability of default and offering the lowest interest rates, while loans with grades further down the alphabet are considered to have higher probabilities of default and offer higher interest rates. APRs for P2P consumer loans from some of the largest platforms have ranged widely from 5.99% to 36%, according to a report by theU.S. Treasury.

How much can I borrow?

Borrowing minimums and maximums for consumers can vary from platform to platform and can range from as little as $1,000 to as much as $40,000.

What is the application process like?

Unlike bank loans, applying for loans from P2P platforms can be done entirely online. Filling out an application often takes no longer than 10 minutes, according to the PwC report, and applicants are sometimes informed of funding decisions within 48 to 72 hours, according to the Treasury report.

Who is my lender?

Funding for a single loan typically comes from a variety of sources, as opposed to a single lender, as investors seek to diversify their loan holdings by investing in portions of multiple loans. Though the name "peer-to-peer" implies that the lenders are individual investors, other entities, such as largeinstitutional investors, often participate in P2P platforms.

How much will I pay in fees?

P2P platforms make money by charging fees to both borrowers and lenders. Fees charged to borrowers may include origination fees, check processing fees if you don't pay electronically, late payments fees, and fees for unsuccessful electronic payments if, for instance, there's not enough money in your account to cover a loan payment. Lenders tend to be charged fees as well, including servicing fees and, in the case of delinquent loans, collection fees to pay the platform for its efforts to recover money.

It's important to get a good handle on all fees before entering into a loan agreement, as these fees can greatly impact the long-term cost of the loan. Such fees are typically disclosed on the platform's website, though where those disclosures exist may vary from platform to platform.

What happens if I default?

Loans to consumers from P2P platforms are generally unsecured loans, meaning that you don't need to put up collateral to get a loan and you don't have to worry about someone seizing your property to compensate for your nonpayment. But there are other consequences to defaulting on a P2P loan.

The P2P platform could ban you from taking out new loans and turn your account over to a collections agency. Perhaps most importantly, your credit score will take a hit, making it harder for you to take out a loan or to secure credit in the future.

Peer-to-peer lending platforms are regulated. The regulator charged with overseeing a specific platform may vary, butborrowers with complaints about P2P platforms can contact the Consumer Financial Protection Bureau for help.Learn more here.

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