P2P lending is a form of financing that connects an individual or a company seeking a loan to investors looking to lend money. It provides an opportunity to invest and earn a return higher than that provided by traditional banks and savings accounts. Loans are used by companies or by individuals for a variety of reasons, such as:
- Expanding premises, upgrading equipment and machinery and purchasing inventory
- Purchasing cars, obtaining a mortgage and paying bills
A platform (website) is generally used to connect lender to lendee, cutting out the traditional middle man (i.e. the bank).
Why should I lend?
- To make money! $10,000 invested today for 50 years compounded at 15% will be worth almost $11,000,000m when taken out (seriously!). Although the chances of earning this high of a return for this long are slim, if you are willing to take on some risk you will have the chance to earn some nice passive income.
- To help! Depending on the platform used, you could be assisting a 60 year old woman in Latvia pay her bills or investing in a business in Ireland looking to grow.
What are the risks?
As with all forms of investing, there is a risk of losing some or even all of the principal you invested. While losing everything is highly unlikely, loan defaults do occur and are elevated under extreme market conditions, such as credit becoming less liquid in a recession. While average industry default rates for unpaid loans are not available online, I have seen ranges estimate from 0.3% to 6.2% depending on the platform used. P2P is a relatively new form of investing and it is likely that we will see default rates increase when the next global recession occurs.
How can I reduce my risk?
Different platforms provide different opportunities for risk mitigation. Generally, as a rule of thumb, the following can be helpful to reduce your risk and keep returns steady over time:
- Invest in shorter term loans; A one-year loan is generally less risky than a 10 year loan used for the same purposes. We cannot predict the future and a recession in the next few years is inevitable, the only question is when.
- Invest across multiple platforms and multiple loans on each platform; Diversify your risk by investing small amounts in each loan and spread your risk across multiple platforms so that if a platform goes out of business, you don’t lose all your money.
- Invest in other asset classes; Consider investing in stocks, ETF’s, bonds and other asset classes. Investing in asset classes with an inverse correlation relationship (e.g. Stocks and bonds) helps to protect against the downside.
- Do your research; Don’t just invest in loans that provide the highest returns. It is better to make 11% return on investments than to make a 20% return and the loan defaults!
- Know the platform; Each platform is unique and has its own way of reducing risk. For example, many platforms offer loans with a buyback guarantee if a loan has not been paid in 60 days.
How should I start?
Read reviews! Each platform is different and needs a different investment approach. Find the one that suits your investment style and start here – Invest a small amount and increase this as you become more familiar with the platform. I have added reviews on this website and will be adding one for each platform – stay tuned!