How peer-to-peer lending works with bad credit

What is peer-to-peer lending?

On the most basic level, peer-to-peer lending is a personal loan between peers. The challenge with peers loaning to other peers is risk assessment. The lender may not know the borrower’s history of loan repayment or their financial ability to do so.

How peer-to-peer loans work

Here’s how peer-to-peer lending works for someone with bad credit. A peer-to-peer loan is an unsecured loan, meaning the debt is not secured with an asset as collateral.

Financial companies have developed platforms to replicate the peer-to-peer relationship on a much larger scale, by pooling funds from prospective lenders. They have also simplified and streamlined this process to:

• Assess risk for lenders
• Connect borrowers with their peers
• Facilitate the exchange between the parties

P2P lending is an alternative to traditional financing with funding options to help credit-challenged customers borrow the money they need. Peer lenders can earn a bit of interest for putting up the money, while borrowers may save on interest rates compared to other lending options.

Application process

Here’s how the process works:

• Apply online
• Provide details about the funds you need
• A lender will review your credit and evaluate your information

If approved, borrowers:

• Choose from offered interest rates
• Select repayment terms

Once the funding is complete, the money will be deposited into your bank account. Each month you’ll be required to pay the balance due, plus interest, to the lender. 

Credit check

To assess risk, the application process requires a credit check. Typically, a peer-to-peer loan will show as a “soft inquiry” on your credit report. Prior to submitting the application, ask what kind of credit check will be done. Since it doesn’t damage your credit, “soft inquiries” allow you to apply to multiple P2P lending companies until you find the best fit.

Repayment terms

Many P2P loans are made available in 3 or 5-year terms with monthly payments required for repayment. In addition to the interest rate, you’ll likely pay an origination fee as well. This can be a flat fee or a percentage of the entire loan amount, depending on the company.

Credit score affects peer-to-peer lending

Another important aspect of P2P loans is the reward/risk factor you’ll be graded on when you apply for a loan. Investors can choose to fund riskier or less risky loans, from grades A to F and beyond.

Below is an example of the borrower interest rates based on the grading system:

• 32% - 7.99% (Grade A)
• 24% - 11.49% (Grade B)
• 74% - 15.99% (Grade C)
• 99% - 21.49% (Grade D)
• 99% - 26.24% (Grade E)
• 24% - 30.74% (Grade F)

For most peer-to-peer lending companies you’ll need a credit score of about 620-640 to qualify for a loan. So even if you don’t have perfect credit, you may qualify for a lower interest rate compared to credit cards.

In addition, peer-to-peer loans often require funding from multiple lenders to equal the total amount requested by the borrower. These “micro-loans” help you match up with the best lender to create a financial win-win for everyone.

5 reasons to apply for peer-to-peer lending

Having imperfect credit can make it difficult to be approved for traditional financing. For individuals in this situation, peer-to-peer lending is a welcome reprieve.

Here are five reasons why applying for a P2P loan can help you get the funding you seek:

1.Higher Chance of Approval

Since peer-to-peer lending companies function differently than traditional financial institutions, they may offer a higher approval rate to individuals and business owners. While they still have similar standards and bank-regulated security measures, they have less overhead and are better able to deal with individual investors. This may net a higher chance of approval for you and less red tape.

2. Perfect for Imperfect Credit

A traditional personal loan is approved by reviewing your credit score or credit report. It doesn’t consider other factors, such as paying your rent on time or employment consistency. Peer-to-peer loans have a unique process for determining creditworthiness.

3. Lower Interest Rates

Compared to high credit card interest rates and fees with payday loans, peer-to-peer lending companies offer loan options with lower interest rates.

4. Larger Loan Amounts

Peer-to-peer loans may be as much as $35,000. This larger loan threshold can be very helpful when consolidating multiple high-interest credit card debts into one smaller-interest rate loan.

Access to Fast Cash

With some peer-to-peer loans, funding can be fast. Once the process is complete the funds are transferred directly into your checking account.

Some drawbacks of peer-to-peer lending

While there are some awesome benefits to using peer-to-peer lending for bad credit, there are some drawbacks to be aware of.

Credit score below 600

Most P2P lending companies won’t approve a borrower if their credit score is less than 600. Although they offer loans to borrowers with bad credit, they draw the line at 600.

Availability

It’s important to note that each state has its own laws about peer-to-peer lending so it may not be available in your area. Be sure to check the availability in your state.

Unsecured debt

Peer-to-peer loans are unsecured debt, which means they are not backed by an asset like a car or home. It also means that if you cannot repay your debt, you could be sent to collections.

Origination fees

Some peer-to-peer loans require origination and loan application fees of up to 6% of the total loan amount.

Picking the best peer-to-peer loan with bad credit

There are new peer-to-peer lending opportunities popping up all the time. Many of them aim to give you a better chance of getting approved for financing -- even if your credit score is lower than 600.

Do your homework

It’s important to do your research. Make sure these new start-ups are accredited by the Better Business Bureau and have bank-level security. Be sure to review the entire list of fees, terms, and conditions before finalizing which P2P loan is the right choice.

Ask questions

If you’re not sure which peer-to-peer lending company is the best option, ask around for recommendations. Some P2P lenders depend on individual investors to fund your loan in increments of $25 while others will put up the funds themselves.

Shop around

You can always apply for multiple peer-to-peer loans since they only require soft credit inquiries and won’t have a negative impact on your credit report.

Final thoughts

The process of financing can be a difficult proposition. And doing so with bad credit makes the process even more grueling. While most major banks may not touch a credit score under 600, there are other options. Equipped with some of these tips we’ve outlined, you can feel confident knowing that peer-to-peer lending may be the right financing option for you.