Small time entrepreneurs and individuals found a cheaper option to finance and start their businesses online. With banks offering high interest in loans, credit investigations and onerous amortization obligations, online communities raised money and lend it to complete strangers. This is called Peer to Peer lending or P2P.

Peer to Peer lending is a type of “social lending” wherein the lender would bid money to finance a loan application from a struggling entrepreneur from a different country or any prospective person with reasonable need to acquire loans. These loans are needed to start up a business, finance a significant project or help a third world person to start at business and become productive. Voluntary investors pool the funds, send it to the online marketplace like http://Prosper.com, MicroPlace, Zopa or Kiva and delegate the collection process to a collecting agency and charge them with rates lower than what banks offer minus the administrative process.

Loans are divided among lenders and payments are sent directly to the P2P sites which then distribute the money to lenders and report non payments to credit agencies or collection firms. Formal arrangement seems to make people more conscious about repayment terms without any bank involved in the process.

It started when consumer’s started to doubt financial institutions capabilities of helping them alleviating from loan payments with high interest rates and therefore, their ethics was being questioned. The maverick online companies’ attitude toward this predicament is if they can ge
t this done cheaper between ourselves, what do we need a bank for?

There are two variations of Peer to Peer Lending on the Internet, the first one is Online Marketplace model and Family and Friend Model. The marketplace model of peer-to-peer lending connects borrowers with lenders through an “auction process” in which the lender who offering the lowest interest rates “wins” the borrower’s. Some loans are packaged and resell the loans but ultimately, they are sold to different individuals.

The “family and friend” model lets go the auction process and concentrates on lenders and borrowers who already have prior knowledge of each other and formalize an online collaboration and debt servicing. The advantage of the “market model” benefits the borrower with its match-making aspect to the lender that offers the lowest interest rate for loans. These loans are unsecured and therefore, risky.

Lenders charge enough to cover defaults in payment and still profit from the investments. There is also a strategy of repayment which is shame. People who borrow repay real world co-ops because they fear losing face among peers. Their objective, therefore, is to make their small business profitable and regularly repay the loans to conduit collection agencies.

The peer to peer lending process uses “social computing” phenomena such as internet blogs, podcasts and participation from online volunteers to match borrowers with prospective lenders. Loans become cheaper as a result while lenders can earn more from other investments. Many investors believed that they get higher returns from 11-13% returns without much management while borrowers get lower rates and less hassle.