Tag Archives: how p2p lending works

P2P lending’s high return rates explained: Alternative Lending Landscapes

Anyone who first hears about peer to peer lending and its amazing high-netting return potential is incredulous about all of its claims…I was…you were….everyone was! It just sounds like a scam.
After my initial skepticism was overcome (through thorough research and a bit of trial and error) I got hooked but still found it hard to explain to others how it all works: P2P lending’s high return rates explained.

On this website I have previously explained the basics of how p2p lending works but I kept on struggling finding a proper explanation for how and why peer-to-peer lending platforms are capable of generating annual return rates between 10% and 30%….those numbers just sound too crazy to be true….
By now I know they aren’t fantasy as I managed to make a 20.92% return on one platform and 15.59% on some other….
With this post I will explain how exactly p2p lending platforms are capable of generating such high ROI for its lenders…

Alternative lending landscape: Payday, Micro, Online & P2P Loans compared

The rise of the internet and deregulation of traditional banking and lending were the enablers of a new alternative lending landscape that emerged at the turn of the century.
Basically there are different types of loan offerings for different type of needs. And we have to look at the different type of loan offerings to understand the high interest return rates being offered by p2p lending platforms.

Payday loans

Payday loans (see infographic below) are small cash advances at a very high interest rates to be paid back when the borrower receives his next paycheck. Common interest annual percentage rates (APR) are in the 391-521% range!!!!!!

Most borrowers using payday loans have bad credit and low incomes and therefore may not have access to credit cards and are forced to use the service of a payday loan company. Payday loan providers therefore can charge exorbitant high interest rates which are calculated on a daily or weekly base e.g. $17.50 interest fee per $100 borrowed for seven days. Most loans are for 30 days or less with loan amounts usually between $100 to $1,500.

The borrower typically writes a post-dated personal check in the amount they wish to borrow plus a fee in exchange for cash. The lender holds onto the check and cashes it on the agreed upon date, usually the borrower’s next payday. These loans are also called cash advance loans or check advance loans.

In the USA alone 12 million people use payday loans with a total borrowed amount of $7 billion.

Micro loans

Micro loans are a mission-driven form of finance aimed at small business owners who want to borrow $50,000 or less. The interest APR is commonly in the 8-22% range.

According to the Small Business Administration, its microloan program provides micro loans in order for businesses used “for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery and/or equipment.”

In banking terms, a microloan is a very small loan ranging from $500 to $100,000. Historically, banks in the United States haven’t particularly liked dealing with microloans because they have not been profitable financial products for them to market. Other financing companies and institutions have filled this void.

Online loans

Typical loans are for small business owners who want/need quick money and don’t mind paying a hefty fee in exchange for speed. Typical annual percentage rates range from 30-120%.

In its broadest sense, online lending is any kind of loan that’s not directly from a traditional bank and often online lenders are technology companies that use different methods to communicate with clients, base rates and approval on metrics other than your FICO credit score and similar traditional measurements and apply a different (frequently streamlined or automated) approval process compared to traditional lenders. This enables them to provide loans super quickly when needed by a borrower.


alternative lending landscapes: p2p lending's high return rates explained through payday, micro, online loans
Alternative lending landscapes: payday, micro, online & peer-to-peer loans compared

P2P lending’s high return rates explained

p2p lending marketplaces arose in 2005 by combining the alternative finance services as described above with crowdfunding. Basically p2p platforms cut out the middleman aka the payday/micro/online loan provider by bringing borrowers and lenders directly together through their platform/marketplace. By doing this p2p lenders don’t need to have cash at hand themselves which greatly reduces their costs. Their core competence is the platform technology and loan approval automation. By charging small fees (typically around 1%) they can create a highly profitable business that is beneficial for them, the borrower and lender. The borrower can find loans with lower APR’s and the lender can get higher ROI on his investments in this new p2p lending model. Win-win-win for all three parties.

The high return rates investors can make on p2p lending platforms are understandable if you look at the loan services they compete with. Payday loans, micro loans, online loans all charge super high annual percentage rates to their borrowers. p2p lendng platforms offer these loans too but at much lower percentages due to their low cost structure. In that light a payday borrower loaning at say 30% interest on a p2p platform is not strange at all as he would pay a multitude of that through a traditional (payday) loan institution. And an accompanying ROI of 20%+ for lenders/investors is a logical consequence thereof. Just very sound business principles at work here.

Hope this post was useful in understanding better how p2p lending platforms are capable of generating high return rates for lenders. And it definitely helps explaining how I was capable of making a 20.92% return on my investments through one of my favourite p2p lending platforms here.

Question? post them below in the comments…


What is peer-to-peer lending? – a visual explanation in infographics

p2p lending is a very new market and finance instrument that emerged in 2005 through the creation of the world’s first p2p lending marketplace Zopa. Ever since then the field has been developing and growing at an exponential rate and more and more people have heard about it. But what is peer-to-peer lending exactly?
Not many people have crystal clear view of the working of p2p lending. And logically so as each p2p lending platform and marketplace works a bit different than the other one.
Today we will explain you the workings of p2p lending through a bunch of the best infographics and visual illustrations available around the web.

What is peer-to-peer lending?

In its simplest form Peer-to-peer lending, as the name implies, means lending money to individuals, or “peers”, without going through a traditional financial intermediary such as a bank or other financial institution. Instead online p2p lending platforms and marketplaces such as Bondora, Mintos, Crosslend, Zopa, LendingClub,..  work by matching individual lenders and borrowers online. In this way it leads to great rates for both borrowers and lenders because it’s more efficient.

Wikipedia defines peer to peer lending as follows:

Peer-to-peer lending, sometimes abbreviated P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders directly with borrowers. Since the peer-to-peer lending companies offering these services operate entirely online, they can run with lower overhead and provide the service more cheaply than traditional financial institutions. As a result, lenders often earn higher returns compared to savings and investment products offered by banks, while borrowers can borrow money at lower interest rates, even after the P2P lending company has taken a fee for providing the match-making platform and credit checking the borrower.

p2p lending explained in infographics

A picture is worth a thousand words!

This idiom still holds a great deal of truth and hence we bring you a couple of visual explanations of what p2p lending exactly is through some great infographics.

What is peer-to-peer lending? an explanation infographic

How peer-to-peer lending works, infographic

We hope these explanations have given you a better idea of what p2p lending is. If you have anymore questions please add them in the comments below and we will answer them swiftly.

Happy p2p lending.

For a detailed look at my personal experiences investing in p2p lending platforms for the first time have a look here.