Peer-to-Peer Lending: Advantages & Disadvantages & How it Works?

Digitalised peer-to-peer (P2P) lending is a relatively new concept in the world of finance. P2P lending has become increasingly popular in recent years, as it provides an alternative to traditional lending methods that are often slow, expensive, and inaccessible to many people.

What Is Peer-to-Peer (P2P) Lending?

It is a platform that connects borrowers and lenders directly, without the need for intermediaries like banks and financial institutions.

In this blog post, we will explore the P2P lending business model, its benefits and drawbacks, and how it is changing the way people borrow and lend money.

How P2P Lending Works?

P2P lending platforms act as intermediaries between borrowers and lenders. Borrowers apply for loans on the platform, and lenders can choose to fund their loans. The platform performs credit checks on borrowers to assess their creditworthiness and assigns them a risk rating based on their credit history and other factors.

Lenders can then choose to fund loans based on their risk appetite and return expectations. They can invest in multiple loans to diversify their portfolio and minimise risk. When borrowers make repayments, the platform distributes the funds to lenders, minus their service fees, if any.

Regulations around P2P finance

The RBI has issued guidelines for P2P lending platforms to ensure that they operate in a safe and secure manner. These guidelines include requirements for registration, due diligence on borrowers and lenders, and disclosure of information to all parties involved.

The guidelines which pertain to lenders are as follows:

• The maximum amount of exposure that can be taken across all P2P platforms is restricted to Rs. 50,00,000 that must be commensurate with the net worth of the lender. For investments above Rs. 10,00,000 across all platforms, the lender must provide net worth certificate which is certified by a Chartered Accountant.
• The maximum amount that can be lent to one single borrower is capped at Rs. 50,000.
• The maximum investment horizon is limited to 36 months i.e., 3 years.

Apart from the conditions prescribed above, the guidelines specific to the borrower is as follows:

• The maximum amount of exposure that can be taken across all P2P platforms is restricted to Rs. 10,00,000.

As the industry is in nascent stage, there is constant vigilance from the RBI and hence, frequent change in regulations is a possibility.

What are the different P2P lending platforms in India and their brief comparison?

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Advantages of P2P Lending

P2P lending offers several benefits over traditional lending methods:

Lower Interest Rates

P2P lending platforms typically offer lower interest rates than traditional lenders, as they     have lower overhead costs and do not have to pay for physical branches or staff.

Accessible to More People

P2P lending platforms are accessible to people who may not qualify for loans from   traditional lenders due to their credit history or other factors.

Faster Approval Process

P2P lending platforms have a faster approval process than traditional lenders, as they use technology to automate credit checks and loan approvals.

Diversification

Lenders can diversify their portfolio by investing in multiple loans with different risk ratings, which helps to minimise risk and maximise returns.

Disadvantages of P2P Lending

While P2P lending has many benefits, there are also some drawbacks to consider:

Risk of Default

There is a risk that borrowers may default on their loans, which can lead to losses for lenders.

Lack of Regulation

P2P lending is not as heavily regulated as traditional lending methods, which can lead to potential fraud or unethical practices.

Limited Borrowing Capacity

P2P lending platforms may have limits on the amount of money borrowers can borrow, which may not meet the needs of some borrowers.

Limited Liquidity 

P2P lending investments are not as liquid as traditional investments, as lenders may have to wait for the loan term to end before they can withdraw their funds.

How will your returns be taxed?

The repayments received by the lender are the sum of the principal and interest components. According to section 56(2) of the Income Tax Act, 1961, only the interest portion is taxable. It is categorised under the head “Income from other sources”.

As a result, you will be required to pay tax as per your tax slab rate.

The Future of P2P Lending

P2P lending is a growing industry, with more and more people turning to alternative lending methods. According to a report by Allied Market Research, the global P2P lending market is expected to reach $558.91 billion by 2027, growing at a CAGR of 29.7% from 2020 to 2027.

As the industry grows, there will likely be more regulation and oversight to protect borrowers and lenders. P2P lending platforms may also expand their services to include other financial products, such as insurance and investment products.

Conclusion

P2P lending is a revolutionary way of borrowing and lending money that offers several benefits over traditional lending methods. While there are some drawbacks to consider, the industry is growing rapidly and is expected to continue to grow in the coming years.

If you are considering borrowing or investing through a P2P lending platform, it is important to do your research and understand the risks and benefits involved. With the right approach, P2P lending can be a great way to access affordable credit or diversify your investment portfolio.