What Peer to Peer or p2p lending is
What is peer-to-peer lending and is it right for you? p2p lending allows people with money to lend and people who would like to borrow money the opportunity to make these loans without the use of a traditional financial institution. In recent years there have been several online platforms which allow the lenders and borrows to connect and conduct these transactions.
How p2p lending works
The first thing to do is to sign up with one of the online platforms. If you live in the US you have probably heard of Prosper.com or Lendingclub.com, these are two of the major players in the US. If you live in the E.U you might have heard of Mintos or Crowdestor. Once you sign up you need to link a bank account in order to fund loans. Once you have funds loaded you are able to browse different loans that you would like to fund. The interesting thing about this is that you may choose to fund a small portion of the loan allowing you to diversify your funds across several different risk categories as well as loans with different payback periods.
When the borrower makes a payment on their loan, you are paid back proportionately. For example if you were to loan $100.00 on a $1,000.00 loan you would receive 10% of the repayment made until the loan was satisfied. Most of the platforms allow you to invest in small increments of $25.00. You of course can fund more of a particular loan if you like the rate of return and length of the loan.
There are of course some risks
There is a risk of default, where the borrower is unable to repay the loan. If this happens you may loose your investment. There are some platforms (generally in the EU) which have a buy back guarantee or a fund set up to repay investments on loans which default. In the US the loans are sent out to collection agencies and a small portion may be recovered.
You do not have access to information about who the borrower is, and you must rely on the p2p platform to conduct the due diligence on the borrower. Additionally the credit requirements may be less stringent than what a traditional lending institution would require since most of these types of loans are unsecured.
My personal experience
I have dabbled with p2p in the past and most of my loans were done through Prosper. I first started investing in July of 2007 and stopped investing early 2019. Overall I made 47 different loans across the entire spectrum of loan ratings. My overall results were a 6.4% loss. This was due to having 21 defaulted loans. Many of the defaulted loans were in the higher risk zone, but there were also “A” rated loans that defaulted as well. It is difficult to determine what percentage of loans were fraudulent from the start as lenders are not able to access much information about the borrower, only what is reported through the platform.
As with all investments there is some risk of losing money, I felt that p2p lending had a higher risk than I am currently comfortable with. If you are able to go with one of the European platforms I would recommend trying one of them before the US based ones, mainly for the buy back guarantee. However if you are comfortable with higher risk and feel the possibility of a higher return is worth it you may consider allocating a small percentage of your portfolio to p2p lending.