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Need a loan? Thanks to the interwebs, there are more options than a traditional bank loan or heading to the bank of mom and dad. Peer lending, a new(ish) form of digital lending has evolved over the past few years into a loan delivering juggernaut. The premise is pretty straightforward. If you need cash, you fill out some forms, make a plea for your loan, and hopefully get funded by an investor. You should expect to pay interest on the loan, and to pay the loan back at regular intervals over a span of 1-5 years. Interest rates are generally determined by your credit worthiness, and borrowers with good credit will be rewarded with lower interest rates than those with poor credit.
On the flip side, investors now have the ability to deliver funds to people in a pinch, essentially becoming someone else’s bank. The enticement here is that you have the opportunity to collect a decent return on interest. But the rewards do come with risks. As with any bank, there is always the risk that the recipient of your loan will not pay it back promptly, or even at all. Lenders therefore assume the risk that the loans will default, and payments from borrowers arenot guaranteed by peer lending websites.
In order to diminish the risk of default, investors in this platform are generally encouraged to diversify the loans they make. This means spreading out your money by making lots of small loans to lots of different borrowers. The idea here is to diminish the risk that one person won’t pay by buffering your loan portfolio with lots of people who will pay. For example, assume you have $1000 to invest. If you make 100 loans for 10 dollars, and one person doesn’t pay back, it won’t hurt your bottom line that much in the long run. In fact, the interest you make on the other 99 loans should more than make up for the loss. However, if you make 1 loan for $1000 to 1 person, and that person doesn’t pay you back, it’s going to hit you right in the wallet. You will lose your initial investment of $1000 plus the interest you were hoping to make on it.
So next time you need a loan or have a few bucks that you aren’t sure what to do with, perhaps you’ll consider peer lending. Remember that even though these services aren’t guaranteed, they still can provide a useful alternative for the average Joe’s and Jane’s of the world looking to borrow some money or make an investment. Plus, it’s a heck of a lot better than asking your parents!