P2P Lending Investing
Peer to Peer Lending Investing Tips
Peer-to-peer lending (sometimes referred to as P2P lending) is a relatively recent and fast-growing form of debt financing that allows individuals to borrow or lend money outside of the traditional structures of a financial institution. P2P platforms have the ability to rapidly accelerate the process of connecting borrowers and lenders to each other, with the addition of being less expensive than traditional financial institutions. These lower fees can mean better returns for investors and lower rates for borrowers. Interest rates paid by borrowers in P2P lending usually range anywhere from 6% to 28%. These platforms do a thorough credit check and evaluation of the borrower’s ability to repay the loan, just as any bank or other financial institution would.
Investors typically earn about 5% to 6% on their investment, although returns can vary significantly based on the quality of the loans selected and default rates for an individual’s portfolio. Skilled investors can earn 10% to 12% return on investment, if all goes according to plan. As payments are received, one is able to reinvest the money or withdraw it from a P2P lending account. You can learn more about how much can you make peer to peer lending.
P2P platforms charge fees to both borrowers and investors. For borrowers, this usually includes an upfront fee of 1% to 6%. This fee is deducted from the loan amount so the borrower receives less than the amount they apply for. Lenders pay a servicing fee of approximately 1%. This fee is deducted from payments when they are made. In addition, if a loan goes into default, collections fees may be applied however these are normally only charged if any money is collected.
One consideration for borrowers is utilizing P2P lending for a loan that can replace high interest debts, such as credit cards with interest rates above 20 percent. A 9 or 10 percent interest rate is highly advantageous for the borrower in this case, as it reduces higher interest rates, and it provides the lender a strong and competitive interest rate for a passive flow of income.
P2P lending can work well as a form of fixed income for a nontraditional investment portfolio. P2P investments typically have less volatility than stocks as well as stronger returns than conventional debt instruments. Many historically “safe” investments like government bonds often carry low or even negative yields, and P2P offers an appealing alternative.
P2P lending arrangements are unsecured loans in most situations. The burden is on the P2P site to conduct credit analysis, determine the level of risk involved with the borrower, and then match these potential borrowers with investors that are looking to lend money to other people. Each loan issued is assigned a grade, with lower grades and higher interest rates given to borrower’s with poor credit scores and history. Lenders can be as selective as they desire, and choose loans that match their comfort level with risk. Lower grade loans have a significantly higher default rate and many lenders simple do not want to worry about a large number of defaults adversely affecting their portfolio.
The ability to diversify investment across a large number of borrowers is perhaps the single greatest strength of P2P lending. One can achieve great granularity here and most platforms recommend at least 50 to 100 different loans to fully diversify. As an investor, if you lend to just one borrower, you could lose your investment in its entirety. This risk is diversified and leveraged by lending to many people at once. For example, Lending Club lets you invest in “notes,” or portions of loans, in units as low as $25. One might invest $2,500 through purchasing 100 $25 notes, in essence lending to 100 different people. This is a large degree of diversification, which limits default risk to $25 per borrower. Even though default risks can be high, the amount lost often pales in comparison to losses accrued in a volatile stock market environment.
One consideration of importance is how peer to peer lending compares with bonds. While bonds have a place in a traditional portfolio, peer to peer lending offers some advantages. To reiterate the previous point, one way in which P2P lending offers an advantage over bonds is in its capacity for diversification. While a bond price is usually at least four figures, an investor can put as little as $25 in a Lending Club loan, for example. Given a scenario in which $3,000 might be used to buy three different bonds, the same $3,000 could allow for an investment in over 100 loans through Lending Club, allowing for a superior and broad diversification reflecting varying degrees of risk, geographic locations, and other demographics. Bonds simply don’t have this capacity for spread and output. Learn more about lending club investing strategies.
The average life span of a bond is approximately 10 years. The average duration for P2P lending is considerably less, approximately three years, which, when combined with favorable interest rates, makes it a viable and desirable alternative. Because of this, one can generally expect to lend money at higher interest rates than bonds – without the downside particular to bonds that requires an investor to potentially sell at a loss to buy higher paying bonds in a shorter time period. The revolving door for P2P lending is compressed and this helps to mitigate extended time loss and its corresponding value loss within a portfolio.
Most P2P lending involves lending directly to borrowers and then receiving repayments until the full amount of the loan is repaid. Many P2P lending websites allow investors to do this without the additional costs of lending through an investment fund. This makes the investment vehicle more personal by nature. Bond lending, on the other hand, is usually done through investment funds. Because the bond fund manager buys and sells bonds for you at different stages in the life of the loans, the investments become more volatile. This is due to the fact that the fund might buy bonds for much more than they were issued for, opening the purchase to a high degree of risk.
Karteek Patel, the CEO of Crowdstacker, explains the comparison this way: “Investors are probably more familiar with bonds than they are with P2P, but there are really many similarities. The key is to find P2P investments that have been managed and structured with the tried and tested approach used to define bonds. This means looking to lend to businesses with solid track records and excellent prospects. If you are happy to do some reading to check up on the financial health of the business you are lending to – and the better P2P platforms provide all the information you need to do this - then, in our opinion, a P2P investment is certainly as attractive as a bond, and definitely can be easier and quicker to set up and manage, and probably offers higher rates of return at the moment.”
Comparing P2P investing with other forms of financial investing, such as dividend stocks, helps to demonstrate additional benefits. When investing with established P2P platforms, the average P2P return can exceed the dividend yield of on the highest paying dividend stocks. The best part is that the P2P lender does not have to worry about stock market volatility.
In some ways, investments at companies like Lending Club or Prosper can act both like a stock, in terms of growing an investment, or a bond, in terms of protecting an investment. As investors voice concerns about an overvalued stock market or worry about low returns in assets like bonds or dividend stocks, P2P carries a strong desirability. The global P2P market was estimated at over $26 billion in 2015 according to Transparency Market Research in 2016 – and is on pace to reach approximately $900 billion by 2024.
In conclusion, a new way to invest in nontraditional vehicles that serve as alternatives to stocks and bonds is peer-to-peer lending. Using multiple online platforms, both lenders and borrowers can execute loans quickly and efficiently. On the basis of a consistent need for capital on the part of borrowers, investors have a solid network of residual cash flow ready at their fingertips. One can invest in a diversified mix of loans from pre-screened borrowers. Risk can be controlled by focusing on borrowers based on credit score and other factors.
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