How does Peer-To-Peer (P2P) Lending Work?

How does Peer-to-peer Lending Work?

• Peer-to-peer lending operates through dedicated online platforms that serve as a meeting place for lenders and borrowers. To participate, users must register on the platform, typically requiring basic personal information and payment of a registration fee.
  
  It's important to compare different platforms to find the best fit for your needs.
  
  
• If you're a borrower, you must provide additional details such as your credit history, income level, and employment status. While P2P lending doesn't solely rely on credit scores, having a strong credit profile can potentially secure lower interest rates.
  
  
• Once you've uploaded your information, you'll specify the desired loan amount and approve the potential interest rate you may receive.
  
  At this stage, lenders review the loan listing and decide whether to fund it.
  
  
• Once approved, you, as the borrower, will receive the loan amount. Single or multiple lenders can fund it with a share in the loan.
  
  Repayments are made through the P2P platform, ensuring timely payments. If multiple lenders are involved, repayments are automatically divided based on their respective shares in the loan.

Initially, P2P platforms were primarily utilized by borrowers facing challenges with traditional loan sources. However, with the rise of structured platforms facilitating social funding, even creditworthy individuals are turning to P2P lending. This is because they may secure lower interest rates than traditional banks.

Who Can Lend Via a P2P Platform?

Any individual with a valid PAN Card and a bank account in India can become a lender on a P2P platform. This includes entities such as HUFs, partnership firms, or any other artificial person that is incorporated or not as well.

Points to Keep in Mind

• The maximum loan duration that a lender can offer is 3 years.
• The total amount that a lender can have across all P2P platforms is capped at Rs. 50 lakhs.
• A borrower cannot take a loan exceeding Rs. 10 lakhs from all P2P platforms combined.
• No single lender can extend more than Rs. 50,000 to the same borrower.

How is P2P Platform Regulated?

Despite the high level of risk that is associated with P2P platforms, they are considered to be safe. They come under the purview of the Reserve Bank of India. 

The regulatory framework for P2P lending is established through the Master Directions for NBFC Peer to Peer Lending Platform, issued in 2017. Key aspects of the regulations include:

• P2P lenders must obtain a Certificate of Registration from the RBI.
  
  
• All NBFCs on the P2P platform must register with the Department of Non-Banking Regulation in Mumbai.
  
  
• A maximum leverage ratio of 2 must be maintained by all P2P lenders, meaning they should ensure that their outstanding loans do not exceed twice the amount of their capital.
  
  
• The P2P platform must maintain a minimum net fund of Rs. 2 crores.
  
  
• All P2P platforms are required to comply with RBI guidelines.

As the RBI regulates P2P lending, borrowers and lenders can be confident in its security.

Tax Implications of P2P Lending

• As per Indian Income Tax provisions, only the interest is taxable, not the principal amount. Interest income is shown under "Income from other sources" as per section 56(2) of the Income Tax Act, 1961.
  
• This interest amount is added to the lender's total income and taxed at the applicable income tax slab rate.
  
• TDS (Tax Deducted at Source) on interest is governed by section 194A of the Income Tax Act, 1961.
• TDS is deducted if the borrower is an individual liable for tax audit and the interest payable to any lender exceeds Rs. 5,000 in a financial year.
• Peer to Peer lending platforms merely act as intermediaries, and it is the borrower's responsibility to comply with TDS provisions.
• The principal amount in a loan default cannot be claimed as capital gain/ loss.
• Loan interest income is exempt from GST.
• GST applies to the processing fee charged by P2P lending platforms.
• Lenders can claim GST input credit on processing fees and registration fees by providing their GST number to the platform.
• The 2022 budget proposed tax benefits for P2P lending investments under Section 80C of the Income Tax Act or special provisions to lower tax rates. This aimed to incentivize investors to participate in P2P lending and increase purchasing power.

Pros of P2P Lending

Some advantages of P2P lending are listed below-

• Access to Funding

P2P lending provides an alternative funding source for individuals who may face difficulties obtaining loans through traditional channels.

• Competitive Interest Rates

P2P lending platforms often offer competitive interest rates compared to traditional lenders, benefiting borrowers with favourable terms.

• Streamlined Process

P2P lending simplifies borrowing by leveraging online platforms, making it convenient and efficient for borrowers and lenders.

• Diversification for Lenders

P2P lending allows lenders to diversify their investment portfolios by spreading their funds across multiple borrowers, potentially reducing risk.

Cons of P2P Lending

Now that you have learnt the pros have a look at some cons too-

• Higher Default Risk

P2P lending carries a higher risk of default than traditional lending due to the possibility of borrowers failing to repay their loans.

• Limited Regulatory Protection

Unlike traditional banks, P2P lending platforms may have limited regulatory oversight, potentially exposing borrowers and lenders to fewer consumer protections.

• Lack of Transparency

Some P2P lending platforms may lack transparency regarding the borrower's financial history and creditworthiness, making it challenging for lenders to assess risk accurately.

• Potential for Fraud

P2P lending platforms can be susceptible to fraudulent activities, including fake borrowers or lenders, requiring users to exercise caution and thorough due diligence.

Conclusion 

P2P lending has revolutionized the borrowing landscape by offering a convenient crowdfunding platform for all types of borrowers.

Lenders have found an attractive investment avenue with the potential for higher interest rates. Registering on a reliable and RBI-regulated P2P platform opens doors to accessing funds efficiently. However, it is essential to exercise caution and consider the interest rates and other charges associated with P2P loans.

You can make the most of this popular lending alternative by staying informed and making informed decisions.

Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.