Discover how P2P lending works in India, its returns, risks, tax treatment, and the impact of the latest RBI regulations. This guide helps investors understand whether P2P lending is a suitable investment option for their portfolio.
Lending to our peers has always been part of our lives, whether it’s extending credit to a friend in need or giving a loan to a distant relative. But these informal arrangements usually come up with uncertainties like no formal terms, no interest, and no way to judge repayment capability.
P2P lending offers a structured and regulated version of this age-old practice. Here, you can lend money to peers by analyzing factors like borrower profiles, credit grades, and their income levels. And because lending happens directly, the returns often exceed traditional savings products and can help you stay ahead of inflation. But it’s not quite as effortless as it appears. Those higher returns come with nuances, and it’s worth taking a closer look before deciding if it fits your investing style.
In the sections ahead, we’ll break down how P2P lending works, the shifts made by the RBI, the risks and rewards involved, and most importantly, what it means for you as an investor evaluating this avenue. Let’s get started.
What is P2P Lending?
Peer-to-peer (P2P) lending is an alternative financing model that connects individual lenders like you with people or businesses seeking credit via platforms regulated by the Reserve Bank of India (RBI). By cutting out the intermediaries like large banks and NBFCs, P2P platforms reduce paperwork and processing time, lower costs for borrowers, and can offer higher returns to you.
Since many P2P loans are unsecured, you as a lender must carefully assess the credit risk of the borrowers. Here is how P2P platforms help you assess the creditworthiness of a borrower.
Borrower Risk Grading in P2P Lending
Most P2P lending platforms follow a structured grading system to help you understand how risky lending to a particular borrower might be. Borrowers are typically graded from A to G, where A indicates the lowest risk, and G signals the highest. Behind these grades is a detailed evaluation process that looks far beyond just a credit score.
Platforms analyze the borrower’s income stability, employment history, existing loans, bank statement patterns, and debt-to-income ratio to understand how comfortably they can repay the loan. This grading system gives you a clearer picture of who you are lending to and what level of risk you’re taking before committing capital. Since the lenders bear the default risk, platforms don’t conduct a similar background check or assign grades.
And while this system has made lending more organized, the P2P industry has had major gaps in the past. As a result, the RBI had to strengthen regulations by introducing significant regulations to curb fraud and other malpractices in the P2P industry. This move caused the industry’s assets under management to take a nosedive, falling more than 80% from about ₹10,000 crore a year ago to ₹1,500 crore as of August 2025.
While the sector is still adjusting to these regulatory shifts, the core mechanism behind P2P lending remains the same. Let’s take a deeper look at its working mechanisms.
How Does P2P Lending Work in India?
P2P lending platforms in India optimize technology for connecting you with the borrowers, handle the data and manage the entire user journey. Here’s how that process unfolds, step by step:
Step 1: Registering on the platform
Both you and the borrower begin by creating your accounts. Both parties need to submit their basic details to complete the KYC process. However, borrowers are required to submit additional documents like PAN, Aadhaar, income proof, bank statements, and employment details for a more thorough background and credit check.
Step 2: Evaluating the borrower’s profile
The platform then assesses the borrower’s creditworthiness using proprietary algorithms and assigns a risk grade that determines the interest rate range available to them.
Step 3: Listing the loan request
After evaluation, the borrower’s loan application, including the amount, tenure, and interest range, is published on the platform for potential lenders to review.
Step 4: Lenders choosing and funding loans
You can then browse verified loan listings and decide which requests to support (typically loans that can generate higher returns than traditional fixed deposits). Most P2P platforms in India offer fractional lending, where multiple lenders can contribute small amounts to the same loan for spreading risk.
Step 5: Borrowers repaying through EMIs
Once the borrowers receive the loan amount, they start repaying the loan in monthly EMIs similar to a bank or personal loan. The EMI covers both the principal and the interest amounts.
Step 6: Lenders receiving their EMI returns
Each EMI is automatically split among lenders based on your individual contribution and credited to your platform wallet. You can then withdraw the funds or reinvest them in new loans.
The operational flow of P2P lending makes more sense when you understand the next important layer which most beginners overlook; taxation.
Taxation of Different Types of P2P Loans
P2P platforms host different kinds of loans, and each comes with its own tax treatment for both borrowers and lenders. Here’s how taxation typically works across the main loan categories.
Personal Loans
For Borrowers
Personal loans taken through P2P platforms for everyday needs like home repairs, medical bills, or consolidating debt don’t offer any tax deductions. The interest you pay is treated and taxed just like any other personal borrowing.
For Lenders
Any interest earned on personal loans is considered taxable income. It must be reported under “Income from Other Sources”, based on the statement issued by the P2P platform at the end of the financial year.
Business Loans
For Borrowers
If the loan is used for business activities such as expansion, buying equipment, or working capital, the interest can generally be claimed as a business expense. This reduces the borrower’s taxable profits.
For Lenders
For you, business loans don’t receive any special tax treatment. The interest earned is still taxable as “Income from Other Sources”, regardless of how the borrower uses the funds.
Real estate-linked Loans
For Borrowers
When borrowers take P2P loans for real estate purposes, like renovating a rental property or supporting property-related operations, the interest may be treated as a business deduction, depending on their tax structure and how the property is used.
For Lenders
You earn interest the same way they would from any other P2P loan, and it is taxed under “Income from Other Sources”. The borrower’s purpose doesn’t change how the lender is taxed.
With the framework and tax structure in place, it’s easier to make sense of the process. Let’s walk through an example to see how everything comes together.
Example of P2P Lending
Let’s assume that Riya needs some capital to expand her business, for which she signs up on a P2P lending platform. After completing the formalities, her borrower profile is graded and she receives her interest rate and amount limit.
Amount required: ₹80,000
Borrower rating: B
Interest rate: 16%
Maximum credit limit: ₹7,00,000
Two lenders on that platform, Arjun and Meera, fund half of Riya’s loan each.
Arjun’s share: ₹40,000 at 16%
Meera’s share: ₹40,000 at 16%
Their contributions go into a secure escrow account, and once fully funded, Riya receives the amount in her bank account after the platform deducts its processing fee.
Over the next 12 months, Riya repays the loan in EMIs that are automatically split: Arjun and Meera each receive 50% of every payment (proportionate to their investment share).
Total interest generated: ~₹6,400 (₹80,000 on 16% interest)
Arjun’s share: ₹3,200
Meera’s share: ₹3,200
But this is the pre-tax amount. Let’s see how taxation affects these earnings.
Since Riya used the loan for her business, she can deduct the ₹6,400 interest she pays as a business expense, reducing her taxable income by the same amount.
If she’s in the 30% tax bracket, this deduction saves her ₹1,920 in taxes (30% of ₹6,400).
Arjun and Meera, however, must pay income tax on their returns.
If they’re in the 20% tax bracket, their ₹3,200 earnings each become ₹2,560 after taxes (₹3,200 minus ₹640 in tax).
This example shows how both borrowers and lenders experience P2P lending, the real returns, and actual costs on both sides of the transaction. But to decide whether this model genuinely fits your investing approach, you also need clarity on what makes it attractive and what could potentially go wrong.
Advantages and Disadvantages of P2P Lending
For many people, the appeal of P2P lending lies in its flexibility and accessibility compared to traditional credit channels. Here are some of the key advantages:
Advantages of P2P Lending
1. Attractive returns for lenders
You have the opportunity to earn higher returns than traditional FDs or savings accounts, with potential returns ranging from 10% to 15% depending on the borrower’s risk grade.
2. Easier access and faster approvals for borrowers
Borrowers benefit from quick, online approvals and minimal paperwork, making it easier to raise funds for personal or business needs in far less time than banks.
3. Diversification through fractional lending
You can spread your investment across dozens of borrowers in small amounts, reducing the risk associated with relying on a single borrower.
However, despite the convenience, P2P lending comes with specific challenges that both lenders and borrowers should be aware of before participating.
Disadvantages of P2P Lending
1. Higher default risk
Since most P2P loans are unsecured, the chances of borrower default are higher, and you may lose part or all of your invested capital.
2. Limited protection and liquidity
Unlike bank deposits, P2P investments aren’t insured, and funds are usually locked in for the entire loan tenure, with no easy way to exit early.
3. Lack of regulatory oversight
Up until recently, the P2P industry faced major regulatory oversight. Hence, the whole financing model was unsecure and vulnerable to fraud and malpractice. As the industry is in its growing phase, so are the rules and regulations evolving with it.
These issues highlighted the need for stronger checks in the industry and prompted the RBI to tighten how the entire P2P ecosystem operates.
RBI’s New Regulatory Changes for the P2P Lending Industry
The RBI’s recent updates reshape how P2P platforms operate and what lenders should expect. Here are the key changes that matter most to retail participants:
- No credit guarantees or return promises: Platforms can’t assure returns or cover defaults anymore. Lenders now carry the full risk. This makes borrower assessment more important than ever.
- Stronger disclosure rules: Platforms must share clearer borrower details (with consent) and publish monthly NPA data, including actual losses. This gives lenders a more realistic view of portfolio performance.
- Tighter fund-handling rules: All transactions must move through escrow accounts, and funds can’t sit idle for more than one business day (T+1).
- Reinforced lending caps: A lender’s total exposure across all P2P platforms remains capped at ₹50 lakh. However, lenders wanting to lend more than ₹10 lakh must get an approved net worth certification from their chartered accountant.
- Restrictions on cross-selling and platform behavior: Platforms can’t push unrelated products or act like lenders, ensuring they stick to matchmaking and transparent operations.
The Future of P2P Lending in India
The future of P2P lending in India will likely look very different from its early years. With the RBI tightening rules around disclosures, escrow management, credit guarantees and platform behavior, the industry is gradually moving toward a more transparent, accountable, and disciplined ecosystem. These reforms can strengthen trust between the participants, reduce repayment uncertainty faced by lenders, and create a more reliable environment for both borrowers and lenders.
At the same time, P2P lending stands at a crucial position to uniquely address one of India’s long-standing challenges: the credit gap. For many individuals and small businesses that struggle to secure loans from traditional banks or NBFCs, P2P platforms can act as a much-needed bridge to timely, accessible financing.
If you’re someone who enjoys evaluating borrowers, weighing risks, and taking informed calls rather than relying solely on passive instruments, P2P lending could become a rewarding space to explore.
As P2P lending moves into its next phase, it’s your decision how you choose to engage with it; cautiously, actively, or not at all.
