Abhi
Have you considered investing in P2P loans seriously? Lending to unknown people may be a relatively new concepts, but then again, P2P lending is here to stay. So here is a look at how it works out for you to be investing in peer to peer platforms, how it pays off, the risks and safety of investments and more.
What is Peer to Peer lending?
Peer to peer loans is a way for an individual to get a loan from another individual at a pre-agreed rate of interest for an agreed term, all regulated by a P2P lending platform.
Say an individual needs money, and they have a poor credit score, then borrowing from a crowd lending site would be easier than borrowing from a bank. It was for this reason the initial set of P2P lending platforms came into existence.
The concept dates back to about early 2000s for the digital peer to peer lending investing practice. However the actual idea of lending money to others and even lending as an investment goes back to the time we were in caves (lending bananas maybe?).
How does P2P lending work?
Consider the money you invest as a Fixed deposit in a bank. How is the bank making money from your deposit and paying you interest? They do this by lending your money to someone you dont know for a higher rate of interest.
The bank then takes a cut and pays you a portion of the interest they earned. In a way, Banks too can be considered as a peer to peer lending and investing platform!
Enough about banks, how does p2p lending work? There are 3 parties to consider:
The investor
Initially, an investor brings his or her money to be lent out to someone looking for a loan. They are looking to earn interest by giving out their money as loans. The investor hopes to earn a higher interest than what a bank would pay. He or She also hopes for lesser risk than putting the money into the stock market and other high risk channels.
The borrower
Once the news of someone lending money spreads, people start lining up for it. In case of P2P loans as the interest rate is high, borrowers tend to be those with poor credit scores. Most common reason borrowers choose Peer to peer loans are:
- clear credit card dues (as the interest rates on credit cards is much higher)
- personal loans
- clear student loans
- auto loan
- get a loan at a lower interest rate than that their credit score will fetch elsewhere
- business loan for starting a small business,
The platform
Peer to peer platforms such as Faircent, Lending Club, Mintos acts as a match maker for the investor and borrower. They simplify the lending and borrowing process. More importantly, they bring a structure and added layer of safety and security for the investors funds.
P2P lenders and those looking for a loan are aggregated by the P2P site. The credit worthiness, past history, capacity etc of the borrower are rated by the lending platform and a score assigned to each borrower. This score decides how much interest is charged on the loan. Higher the score for a borrower, the lower the interest and lower the chances of a default.
Investing in P2P Loans
Investing in P2P loans means you get a return on your investment that is around 6% to 25%. Much higher than fixed deposits, bonds, CDs, etc. This also means that the risk is high too as:
- You are giving money to someone you have no idea about
- Higher chances of default as borrowers have a history of default and poor credit score
Now, how does p2p lending work out for you as a great form of investment despite these shortcomings…
Earning potential
Peer to peer investments carry interest ranging between 6% to 25% depending on who and where you are giving the loan to. Safer the loan, lower the interest. So borrowers with a rock solid profile and great credit scores pay you lower interest.
On the other hand, if you are looking at making a higher return on your investment, then you will have to accept a higher rate of interest.
In your case, if you are considering adding peer to peer loans as an investment to your portfolio, you can consider finding a balance. Medium risk loans, that have a low chance of default, and still offer a better return than your other traditional investments.
Risks and Safety
Like I said, with higher interest, you face a higher chance of default. The P2P platforms have you covered to an extent in this regards. They vet borrowers and collect proofs, identification documents and credit scores to ensure loans are paid back on time and in full.
The larger Peer lending platforms have buyback guarantees and minimum promises that give you some sort of assurance. This means, you stand a chance of getting back your money in case of default. Nevertheless, the risk is somewhat high up there along with stocks and crypto investments.
Should you do it?
Absolutely. As the example above, the money you put in the bank is lent out to someone you don’t know. Just that there is lesser risk for you as most banks are regulated by the government. In the case of peer lending, there is no regulation, which makes is riskier, then again the returns are in line with the risk.
I would not advise you to go crazy and loan out everything you have to strangers. But you should add Peer to Peer loans to your portfolio. They carry the same amount of risk as investment in small cap stocks and to an extent much lesser risk than crypto investments. More over, this offers a way to diversify the investments in your portfolio, as well as geological hedging.
The Geological factor in P2P
Peer to peer loan platforms allow you to invest money into markets you generally do not have access to. Eg: You will find your self giving a loan to a taxi driver in Ukraine to buy a car or even a personal loan or small business loan to a mother of 3 in Poland.
In terms of your portfolio, this offers great diversification opportunities. Say, your country is in a political turmoil, or there is a natural disaster that wreaks havoc in your area. This may screw up your stock and other investments that are within your country. But, the money lent out to others is much safer.
My P2P investments
I personally have about 6.7% of my investments in peer to peer lending platforms given out as loans. I have a high risk appetite and usually end up with riskier loans that pay about 15% to 20% as interest. In the past about 15% of them have defaulted with me getting money back after a couple of months or at times losing the money.
Check out my latest investment portfolio and updates here.
Some frequently asked questions on Peer to Peer investing
Yes, it is legal. P2P lending is the same as providing money to a friend, in this case you are lending to an unknown person.
It is a form of investment where you as an individual provide money through a platform to other individual borrowers who pay you back over a period of time with interest.
Yes, peer to peer loan platforms have been around for over 10 years now and investors have been making money consistently on the money given out as loans. P2P lending carries the same risk tag as other investments with similar rate of returns
You can start from as little as $10. This varies from platform to platform, but most platforms have a very small barrier for entry and investment.
Banks have high criteria for giving out loans. Individuals who have poor credit scores and history of default find it very difficult to get a loan from the bank. For them, P2P platforms are a better alternative to a bank.
