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Peer-to-Peer Lending for Bad Credit

Aparna Iyer
People generally opt for peer-to-peer lending when they find it difficult to borrow a significant sum from banks and credit unions. Here, we discusses the reason for the growth of peer-to-peer lending for bad credit.
Peer-to-peer lending may be defined as one convenient option to borrow a sum from a known entity. The roots of this system are old; they are recently launched, sophisticated reminders of the good-old barter days, when trading goods for goods was the norm.
However, the goods-for-goods rule gradually converted itself to the goods-for-money rule. The relaunch of this system proves advantageous, for the borrower approaches an individual he is fairly acquainted with and not a financial institution. Thus, instead of a bank, you would borrow the required sum from an individual.
In P2P lending as it is popularly known, you drop the component termed Bank from the plot. Peer-to-peer lending does not necessarily mean lending money to, and borrowing money from people, who are personally known to you.
It, certainly, is a plus, if you are well aware of the person and his status quo with regard to financial matters and creditworthiness. However, it is possible that the transaction may involve a lender, who is unknown to you.

Growth of P2P Lending Services

A poor credit rating is a deterrent to availing loans at a reasonable rate of interest. The most common reason for the difficulty experienced in borrowing can be attributed to the lack of creditworthiness on the part of the consumer. Sometimes, consumers would like to borrow small sums of money to meet ongoing expenses. 
The problem with traditional lenders is they do not lend sums less than $3000, even if borrower doesn't have a collateral to offer. However, borrowing without a collateral at a favorable rate is possible only if the consumer has good credit scores and history. So this mode of lending for customers with a bad credit report has a great deal of significance.
Some of these issues gave rise to peer-to-peer lending. Prior to the sub-prime crisis, people were able to borrow money by using their built-up home equity as collateral. The fall in the price of real property left most consumers with negative home equity. Thus, home equity loans and home equity lines of credit were no longer feasible.
The consumer had to start relying heavily on other secured and unsecured loans. Secured loans required a collateral that most consumers did not possess, while unsecured loans were disbursed based on credit worthiness of consumer. With bad credit no longer being a deterrent to availing small loans, consumers started flocking to the lenders (P2P) for the same.

How Does P2P Lending Work?

Peer-to-peer lending services work by bringing together lenders and borrowers. The lender is expected to set up an online account and deposit funds via ACH (Automated Clearing House), wire, check, or PayPal. 
A borrower interested in availing loans has to apply online, and post his/her requirements, viz. loan amount, reason for the loan, the credit scores, the existing debt level, and other relevant information. Although the borrower's credit score is considered, the lenders tend to diversify their risk by lending small amounts to a large number of borrowers.
Lenders can lend as little as $50 to the applicants. Even if a few bad-credit consumers do default, the chances of the lender recovering the principal and the interest on other loans is a distinct possibility. The lenders stand to gain in the form of interest and principal on the money that is lent. Moreover, they are not charged an account-maintenance fee.
The borrower has the opportunity to avail loans at a reasonable rate of interest, since lenders are allowed to bid on loans of their choice. Since the loan is sanctioned by the lowest bidder, the auction process has the effect of bringing down the rate of interest on the amount that is lent.
The borrower is also given the opportunity to state his/her case, and try to convince the potential lender of the prudence of sanctioning a loan to the former. The application process is free, and this provides a small measure of comfort to the cash-strapped borrower.
In addition to providing a platform for borrowers and lenders, peer-to-peer lending services need to verify the authenticity of the information given by the consumers and comply with the regulatory requirements. Such services deduct the amount of interest and/or principal from the bank account of the borrowers and dispatch the same to the lenders.
The lending services make money by levying a fee, on the borrowers and the lenders, for servicing the loan. Finally, person-to-person lending can help people with poor credit build their credit scores and credit history, since these lending services communicate the account information to the credit bureaus.