Loan between individuals: everything you need to know before investing

Personal loans: everything you need to know before investing

Highlights

  • Peer-to-peer lending is a mechanism by which people in need of loans are put in touch with people willing to lend.
  • P2P platforms function as an intermediary between the lender and the borrowers and facilitate the process to gain a spread.
  • Unlike traditional lenders who primarily rely on credit score to assess a borrower, P2P platforms set their own checks to assess borrowers’ creditworthiness.

New Delhi: Peer-to-peer lending has been very successful in India lately, fintech companies such as Cred and BharatPe have recently entered the field. P2P lending platforms are also offering attractive returns to investors at a time when yields on fixed income products have declined. However, these higher returns are not without risk. You have to know the risks of investing in P2P platforms. Here is everything you need to know about P2P loans.

What is peer-to-peer lending and how P2P platforms work

Peer-to-peer lending is a mechanism by which people in need of loans are put in touch with people willing to lend. P2P platforms work as an intermediary between the lender and the borrowers and facilitate the process to gain a spread. One can register as a borrower or lender on these platforms after going through a verification process by providing the relevant details.

As part of the process, borrowers undergo a risk assessment and in some cases pay a flat registration fee. Once registered, investors can contact listed borrowers and vice versa. But most of the fintech companies that offer P2P lending service automatically offer loan offers to borrowers based on criteria set by the lender.

Here, proposals are accepted on a first come, first served basis. The interest rate usually ranges from 10% to 28% and the loan term can range from 3 months to 36 months. For example, those who invest in Cred’s P2P platform will earn interest of around 9%, while loans will be disbursed at a rate of 12-13%.

Once an agreement is made between the borrower and the lender, a legally binding contract is signed by them digitally. After that, the loan amount is transferred to the borrower’s account and the borrower makes periodic repayments through EMI over the stipulated period. If a borrower does not pay an IME within a stipulated time frame, a penalty is imposed on the borrower and is payable directly to the lender.

Assessment of borrowers

Unlike traditional lenders who primarily rely on credit score to assess a borrower, P2P platforms set their own checks to assess borrowers’ creditworthiness. Details like employment, income, credit history are retrieved and with the help of technology, borrowers’ personal habits are captured by tracking social media activity, app usage, etc.

Based on these details, borrowers are usually assigned different risk categories based on their creditworthiness. This serves as the basis for determining the amount, interest rate and length of loan eligibility. Some platforms offer borrowers the option of either selecting a loan according to the assigned risk category and paying the predetermined interest rate, or asking potential lenders to bid on an appropriate interest rate, the AND Wealth mentioned in a report.

P2P platforms are regulated

These platforms are regulated by the Reserve Bank of India. All P2P players must register to obtain an NBFC-P2P license to provide P2P lending services. The regulations cover the scope of activity of P2P platforms and prescribe certain prudential standards to be followed by them. In accordance with these regulations, no borrower can borrow more than Rs10 lakh at any time, on all P2P platforms.

Likewise, a lender cannot at any time pay more than Rs 50 lakh on all these platforms. In addition, the exposure of a lender to the same borrower, on all P2P, cannot exceed Rs 50,000. No loan can be sanctioned for an occupation period beyond 36 months. In addition, loans can only be disbursed if the individual lender has approved the loan recipients and all relevant participants have signed the loan agreement.

Is it risky to invest in P2P platforms?

Typically, P2P platforms are used by people who cannot avail loans from traditional lenders like banks because they do not meet prescribed criteria. So, lending to these borrowers comes with risks as these loans are unsecured by nature. In the event that the borrower does not repay the loan, these P2P platforms do not ensure the full repayment of the principal or the interest.

However, in the event of a default, the platforms assist with the collection and filing of legal notices, but cannot guarantee a positive outcome. To be safe, the P2P platform is required to disclose all the details about the borrower including personal identity, amount required, interest rate sought and the credit rating assessed by it. At the same time, the personal identity and contact details of the lender remain confidential.

It can be noted that according to the rules prescribed by RBI, the P2P platform cannot hold the funds invested by the lender or reimbursed by the borrower. These funds must be held in an escrow account, so that the platform itself has no access to the money.

What can investors / lenders do to minimize risk?

Investors are advised not to get carried away by the only interest rate offered. Rather, they should properly go through the borrower’s profile before approving any loan. In addition, one should not completely rely on the risk assessment of the P2P platform. So, don’t give high exposure to one particular borrower. Spread your loans over several borrowers to minimize the risk of default. In addition, regularly monitor the borrower’s profile.

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