story

Peer-to-peer lending: Does it benefit everyone?

Nikhil Paradkar & Sudheer Chava
Posted on March 13, 2018

Those who need a loan are no longer confined to borrowing from traditional banking intermediaries. Peer-to-peer lending via marketplace lending (MPL) platforms is now an option for borrowers as well. Although this kind of lending is still only a small segment of the market, these platforms are experiencing a rapid growth in lending volumes. In 2017 alone, close to 500,000 peer-to-peer loan requests were funded in the United States, totalling more than 6 billion USD1. 

On marketplace lending platforms, individual borrowers post a loan request online and are directly connected with individual lenders. Peer-to-peer lending allows lenders to make their own decisions about whom to support, and the platform offers borrowers personalized interest rates based on the borrower’s personal profile and credit history. So who are these people that request loans on marketplace lending platforms? 

Borrowers’ financial status and needs

Our research challenge studying approximately 1 million US borrowers shows that people who request a peer-to-peer loan are often in a more critical financial situation than most. They have twice the number of trade accounts and credit cards as the average American, and their credit card debts are twice as high. Most tellingly, they use twice as much of their available credit than the US national average. Accordingly, the vast majority of borrowers on marketplace lending platforms indicate in their online loan applications that they aim to use the funds to pay off their most expensive bank debts. However, MPL platforms have no mechanism in place to ensure that these loans are used for the reasons stated on the online application.

A two-tailed story

Our findings suggest that people who take out a peer-to-peer loan do spend the money as indicated: borrowers mainly paid off their bank debts. Our findings also indicate that these borrowers pay-off the most expensive debt on their balance sheets: credit cards. On average, the credit card debts of MPL borrowers decline by over 60% in the first quarter after taking out the loan. We find no evidence of MPL borrowers using peer-to-peer loans to pay down relatively less expensive debt such as auto, mortgage, and student loans.

“Our findings suggest that MPL platforms can help borrowers with a relatively low credit risk. ”

So far, marketplace lending seems to be a worthwhile decision, at least in the immediate horizon. By helping reduce credit card debt, peer-to-peer lending definitively lightens the financial problems of MPL borrowers. But what about the longer-term impact? A longitudinal analysis indicated that this type of lending does not appear to change the fundamental consumption behaviour of individuals engaging on MPL platforms. Although our evidence suggests that MPL borrowers do pay off their credit card debts, we also note that borrowers with a high credit risk (subprime borrowers) are more likely to revert to using their credit cards after this short period of having paid off their debts. In fact, our findings suggest that these borrowers reach their former level of credit card indebtedness within three quarters of taking out the loan. After a year they are even more indebted than before, because they have to pay down both the borrowed MPL funds and their newly accumulated credit card debt. So these peer-to-peer loans seem to have only a short-term positive effect on the financial situation of subprime borrowers. However, in the longer horizon, our findings suggest that MPL platforms can help borrowers with a relatively low credit risk (near prime and prime borrowers) – the vast majority of the MPL clientele. They have lower credit card debts and use their credit cards less after taking out the peer-to-peer loan.

The problem of the subset of subprime borrowers thus lies with the credit card consumption activities after that they have paid off their initial credit cards debts, and can’t be ascribed to the MPL platform. It is important, therefore, that MPL borrowers carefully consider their credit card consumption activities in the months after they take out the peer-to-peer loan and pay off their debts. Our research for the Think Forward Initiative focuses on the potential benefits and drawbacks of marketplace lending and to whom this type of lending is actually beneficial. It could potentially help financial institutions design instruments that help people decide which credit channels are more beneficial, given their financial situation and history.

Please read more about our research in the report that will appear online later this month.

References

  • 1. Authors’ calculations using publicly available data from Lending Club and Prosper Marketplace’s websites.