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What is Peer-to-Peer Lending? Learn Everything About It

What is Peer-to-Peer Lending? Learn Everything About It

From relatives helping in financial emergencies to businesses borrowing money for their needs, India has always embraced the lending culture. Such lending approaches depend on trust or collateral.

This conventional process of lending money has transformed into a technologically advanced process. That's where the discussion of peer-to-peer lending comes into being.

2012 witnessed the advent of P2P lending in India. Since then, it has become the best replacement for traditional lending. In this post, you can get information on P2P lending.

Highlighting the Concept of Peer-to-Peer Lending

What is peer-to-peer lending? When individuals look for a loan, they usually visit financial institutes (like NBFCs) or banks.

But considering your low income, bad credit score, and improper paperwork, banks or financial institutes may reject the loan application. That's where peer to peer lending comes at your rescue.

P2P or peer-to-peer lending is a process of lending money directly to businesses or individuals. Financial institutions do not participate as the intermediary in such deals. P2P lending offers unsecured and secured loans.

P2P transactions occur between two parties via peer-to-peer lending apps or websites. So, it eliminates the work of a middleman (a bank or financial institute). The process connects lenders to borrowers, who need to pay the interest to the lender.

Whether you have low CIBIL scores or low income, P2P can serve you during the need of the hour. A borrower can get the loan to finance the following:

  • Debt refinancing
  • Higher education
  • Expanding the business
  • Conduct personal events like marriage and more.

It's convenient, as you need to visit a P2P lending platform to perform the requirements and borrow money accordingly.

Outlining the Advantages (Pros) of Peer-to-Peer Lending

Below is the list of top benefits of P2P:

1. Better Rate of Interest

Peer-to-peer lending platforms offer excellent interest rates. So, borrowers can get favourable terms by applying for P2P loans on a P2P lending platform.

2. Seamless Access to Funds

Peer-to-peer lending offers the best alternative financial services for people who need liquid cash. Individuals undergoing certain financial difficulties can opt for a loan.

3. Simplified Process

P2P lending makes a borrower's effort to get money easily. All you need to do is leverage online platforms and borrow money accordingly.

4. Improves a Lender's Portfolio

The best options considering peer-to-peer lending for investors can diversify their portfolios. It spreads the funds around different borrowers and reduces risks.

A Few Risks (Disadvantages) of P2P Lending

The following are the disadvantages of P2P lending:

1. Excessively High Risk

P2P lending has higher risks for borrowers if they fail to repay P2P loans.

2. It's Not Transparent

A few P2P lending sites and apps might lack transparency, considering the financial history of the borrowers. So, it makes it more difficult for lenders to evaluate risks.

If the borrower is highly creditworthy, it reduces risks from the lender's point of view. However, it does not entirely make the investments risk-free.

Understanding How Peer-to-Peer Lending Works

P2P lending apps and platforms act as intermediaries between lenders and borrowers. So, it works differently for borrowers and lenders. Read on to understand how it works for investors and borrowers respectively:

For Lenders or Investors

An investor achieves the flexibility to select a borrower. So, it allows them to keep up with their risk appetite considering the investment. With P2P lending, they get valuable information like the borrower's CIBIL history from the platform. Such details help them make better financial decisions.

If the investor does not want to take risks, they can diversify their portfolio around different borrowers. Lenders get repayments monthly, including the interest and principal amount. The lender can either withdraw the fund or reinvest the returns.

For Borrowers

Borrowers must submit certain documents while applying for the loan via the P2P lending platform, such as the following:

  • ID proof
  • Driver's license
  • Passport
  • Address proof
  • Bank statements or utility bills
  • Income proof (tax returns or salary slips)

Borrowers may also submit other documents that support the loan application. After submitting these documents, the P2P app or platform evaluates the candidate's eligibility.

The lending platform determines the borrower's creditworthiness depending on their CIBIL score, income, etc. The borrower receives the amount directly in the bank account after approval of the application.

Now, coming to the repayment process, a borrower can make monthly instalments to repay the amount. This way, they can manage repayments and plan their finances. A borrower should make timely payments to improve their credit score. It makes it easier for them to obtain future P2P loans.

You may also read this: How Can a Personal Loan Improve Your Credit Score?

Outlining the Compliance Requirements for Peer-to-Peer Lending

In India, P2P lending has certain regulatory needs set by the RBI or Reserve Bank of India. The following are the requirements:

  • P2P platforms should have the registration certificate obtained by RBI for its operation.
  • Its minimum capital requirement is INR 2 crore.
  • These platforms should follow the KYC guidelines and AML standards (by the RBI)
  • A lender can lend a maximum of INR 50,000 to a single borrower around P2P platform.
  • These platforms should maintain a minimum 15% capital adequacy ratio.
  • Peer to peer lending platforms should ensure that borrower loans aren't secured and guaranteed by the founders, promoters, or platform.
  • P2P platforms must disclose all details considering the fees, charges, and interest rates to borrowers and investors.

Check out the Regulations of Peer-to-Peer Lending in India

P2P comes under RBI guidelines. So, if a company wishes to provide this financial service, it needs the NBFC-P2P license registration from RBI.

RBI states that when a P2P platform wants to shut down, the board must act as per the pre-decided Business Continuity Plan. This plan includes the details of borrowers and lenders without misusing the private details.

Are Taxes Involved with P2P Lending Returns?

Peer-to-peer lending is where investors earn interest from the loan amount. So, the interest income earned from this type of lending is taxable. As per the income tax provisions in India, the principal amount isn't taxable. Interest earned from peer-to-peer lending is the Income from Other Sources, as per section 56(2).

The lender receives the interest with the income. The tax is based on the tax bracket an investor falls in. Suppose a lender falls in the 30% tax bracket. In such cases, the investor must pay a 30% tax on their earned interest.

Let's point out a peer-to-peer lending example from below:

Suppose you have invested INR 1 lakh in peer-to-peer lending. So, your earned interest from your principal amount is 15%. The total amount of INR 1 lakh is INR 15,000. Thus, if you fall under the 30% tax category, you must pay INR 4,500 (15% of your total interest earned).

Tax deducted at source, or TDS, on the interest is governed by Section 194A of the ITA, 1961. Tax is deductible when the borrower is liable for a tax audit, or the payable interest is over INR 5,000 annually. Note that it's always a borrower's responsibility to follow the TDS provisions.

One cannot claim the principal amount as the capital gain or loss. The interest income for the loan is excluded from the GST amount. GST gets charged to the processing fee that the P2P platform charges.

Lenders might claim the GST input credit on registration as well as processing fees. They need to give their GST number. As per the 2022 budget, there are tax benefits for peer-to-peer lending investments under ITA Section 80C. There might be special provisions to reduce tax rates. This approach can benefit investors by allowing them to participate in peer-to-peer lending.

Last Words – The Future of P2P in India

Are you wondering, 'is P2P lending legal in India?' P2P loans have become popular in India, and such an act is legal. It offers higher returns and a time-saving application process compared to conventional procedures.

The prime advantage is that the RBI regulates P2P lending in India, which ensures transparency between borrowers and investors. Overall, P2P lending has transformed the way borrowers and lenders communicate with one another.

It's noteworthy that P2P can become a significant part of India's financial ecosystem. RBI is working actively to improve the regulations for credit checks and KYC. It aims to reduce fraudulent activities, thereby improving transparency in the sector.

When banks offer 6-7% interest on one-year FDs, P2P lenders can earn more than 10% interest. That's what makes P2P lending a profitable investment solution.

However, there are certain risks to repaying loans accordingly. While risks might make things a bit complex, there's no point denying the fact that P2P is not as scary as equities. Investors can get a higher return with P2P lending. However, one should never undermine the associated risks before making an investment decision.

Now you know the advantages, risks, and taxes involved with peer-to-peer lending. It's your turn to select the best P2P lending platform in India. You can make the lending/borrowing deal wisely by selecting the right platform. Find the best P2P lending app and proceed smoothly.

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