Peer-to-peer lending

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Peer-to-Peer (P2P) lending is a collaborative way for individual investors to participate in lending activities previously limited to banks. The information in this article is oriented toward the two major U.S. companies providing mature lending platforms, Lending Club and Prosper.


Below [1][2]summarizes some of the key aspects of P2P:

  • The P2P companies screen borrowers according to stringent lending standards but can provide loans more efficiently than banks. [3]
  • Accurate risk ratings with associated interest rates are posted for investors.[4]
  • The P2P company issues “notes” to individual investors, who can invest small amounts (as little as $25 each) to diversify across hundreds of loans, and investors are charged fees of 0.5% to 1% of the note’s value, which are deducted as principal and interest are paid.
  • Notes are available in two term periods, 36 months and 60 months.
  • P2P companies recommend holding at least 200 notes to obtain adequate diversification.
  • P2P lending is regulated at the state level, and not all states permit investment. Some states limit investment only to Lending Club or to Prosper. Some states that prohibit investment permit purchase and sale of secondary market notes.


  • Default Risk – Notes issued are unsecured loans and borrowers default more frequently.
  • Single Party Risk – The P2P companies own the loans, issue notes to investors, then collect and disburse payments of principal and interest. Investors do not own the underlying loans. Therefore, in the event of a P2P company bankruptcy, the loans may be considered assets to the company’s creditors. Accordingly, investors should carefully consider the limits to investor protections for Lending Club and Prosper before investing.
  • Interest Rate Risk – When interest rates go up, the market value of existing notes will fall in price because new notes can be found at interest rates more attractive than existing (lower interest rate) notes.
  • Economic Risk – During poor economic conditions, and particularly during periods of high unemployment, default rates for notes could increase substantially.
  • Liquidity Risk – Although there is a secondary market for trading P2P notes, market prices can decline significantly due to a lack of willing and available buyers. Investors holding notes to maturity do not incur this risk.
  • Prepayment Risk - Borrowers may pay back loans early, so lenders reinvesting the proceeds may obtain less favorable rates. Additionally, Lending Club investors incur a pre-payment penalty because they are still assessed the 1% fee against the balance of their "pro rata share of the payment." [5]
  • Competition from Institutions and Individuals – The available pool of attractive-rate notes has declined in recent years due to increased involvement by institutional and retail investors. While the number of P2P loans is increasing, investor demand has been greater. Accordingly, the average interest rate earned and number of loans available per retail investor have been declining since 2013.[6] [7]


  • The personal loan segment is a recently-available segment for retail investors, and provides a new way to add diversification within a fixed income portfolio.
  • Investors who wish to actively manage their fixed income investments can now do so with P2P notes, even with limited capital.
  • Given the small minimum investment per note ($25), a high level of loan diversification can be obtained.
  • While lending standards were initially loose for P2P platforms, today they are more stringent. Additionally, P2P providers update their performance records, including loan default rates and returns, on a regular basis.
  • You can filter loans by criteria that you choose, so you can “personalize” the risk characteristics for each individual loan you select. You can also select groups of notes that fit the amount of overall risk and return you prefer.
  • Personal loans, while risky, provide a high return and different risks than other fixed income investments. For example, personal loan notes are different than high yield corporate notes.
  • Some investors may find it fun to select the individual loans they wish to participate in, and cherry-pick certain loans to attempt “better returns.” There are differences to be found, even between identically graded loans.

Implications to Investors

P2P is neither a simple nor a low cost investment, and therefore is considered inappropriate by most Boglehead investors. Bogleheads generally "take risk on the equity side" rather than with fixed income.

While the personal loan segment is a lucrative area previously limited to banks, it is not clear whether the risk adjusted return, after fees, provides a better risk-adjusted return than comparable investments, such as high yield bonds. P2P should be considered a concentrated investment because of its single party risk. If selected, total investment in P2P should only be a small part of the portfolio (no more than 5%). P2P is not tax-efficient and should be located within tax-advantaged accounts. P2P providers permit IRA accounts.

Investors who might consider P2P useful could be those already including high yield (junk) bonds in their portfolio. The reason is P2P may provide high yield investors additional diversification. P2P and high yield investors should take a corresponding reduction in their equity allocation, since both have a high correlation with equity performance. It is suggested that a high number of P2P notes be held (700-800) for effective diversification, and that maturities for every note be for terms of 36 months, no 60-month term notes included. A best practice for active investors is to acquire notes gradually, over a 36-month period, so a ladder with a portion maturing every month can be reinvested at current rates.


See also


  1. Lending Club Company Website [1]
  2. Company Website [2]
  3. Why Wells Fargo is Terrified of Peer to Peer Lending [3]
  4. How Lending Club Sets Interest Rates [4]
  5. Lending Club Pre-payment Penalty to Investors [5]
  6. Is Peer-to-Peer Lending Over? [6]
  7. Lending Club Average Interest Rate

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