11/13/2014 12:50 pm ET Updated Jan 13, 2015

The Perks of Peer-to-Peer Lending

Peer-to-peer (P2P) lending is a fairly straightforward concept: networked lending between people who want to borrow money with those who want to invest money. Also known as social lending, this form of crowdfunding is facilitated through specialized investment firms, such as Prime Meridian, and websites, including Prosper or Lending Club.

Gaining traction after the credit crisis of 2008, P2P lending has gained clout in the last five years as a viable alternative for obtaining loaned capital, whether as an individual or small business. Currently, P2P comprises just $3 billion of the $850 billion available market in consumer credit, though that number is expected to increase significantly in the near future.

"P2P lending is expanding at an incredible rate as the growth of P2P lending platforms, Prosper and the soon-to-be-public Lending Club, show," says Don Davis, Managing Principal of Prime Meridian Capital Management.

Why borrow from P2P lending?
Tighter credit conditions from traditional banks have deterred lenders from seeking loans in the old-fashion sense. P2P lending offers better credit terms for all parties involved--the lenders and borrowers--and web-based technology makes crowdfunding accessible for anyone with an Internet connection.

Advances in technology have evolved P2P lending even further. The Prime Meridian Income Fund consists of a diversified consumer loan portfolio from an array of creditworthy borrowers. The fund uses a dedicated API, powered by unique credit algorithms, to calculate the lowest risk/highest return loans in the available portfolio.

"Our flagship Prime Meridian Income Fund holds a mature and seasoned portfolio of over 12,000 prime consumer loans. Individual and institutional investors are increasingly interested in using our knowledge, experience and technology to invest in this rapidly expanding space," Davis adds.

Individuals can acquire personal loans via P2P lending for myriad reasons--debt consolidation, mortgages, car purchases, medical expenses--and experience financial perks. Borrowers who took out personal loans with Lending Club to consolidate debt, for example, reduced rates by 31 percent.

"P2P lending allows for an easy way to consolidate credit card debt and other loans to a single source at a lower interest rate," says Davis. "Peer-to-peer lending provides everyday investors with the potential for returns by lending money to individuals and small businesses that often need it the most. It's an investment that feels good in that you're helping these borrowers directly."

Why invest in P2P lending?

With better credit terms, investing in P2P lending increases returns for those who provide capital. Lenders often have the option of bidding on loans and spreading their investments across a variety of borrowers. For example, with Lending Club lenders can invest in fractions of loans in increments as low as $25, allowing a $2500 investment can be spread across as many as 100 different loans.

Lenders can also determine the category of risk for their investments. The higher the risk, the higher the potential return. However, with high risk comes the possibility that the borrower may default.

"For investors who want to allocate larger amounts of money in the space, a very well managed and seasoned portfolio like the Prime Meridian Income Fund or the Prime Meridian Small Business Lending Fund automates the evaluation and lending process, as opposed to individually reviewing and choosing loans -a painstakingly laborious process. As an early investor in P2P lending, we used our experience to develop customized algorithms that automatically invests in P2P loans to manage risk and create value added returns," says Davis.

The future of P2P lending

P2P lending is a growing facet of consumer credit. Much like eBay transformed commerce by eliminating the middleman or Napster cut the need for record companies, P2P lending has removed the need for traditional banks or credit unions.
P2P lending companies like Prosper or Lending Club are still regarded as "fringe" players, as they account for a fraction of the massive marketplace, but the potential for growth in this field is grand, exciting and unknown. Lending Club, despite its size, has caused some ripples in the pool; the company recently filed for IPO, asserting its potential and leadership in the industry. If one thing is certain from past consumer-drive tech leaders: Technology makes historically cumbersome services accessible and efficient, which leads to disruption in a given industry.