How to Invest in Peer-to-Peer Lending – Peer-to-peer (P2P) lending platforms link individual investors with borrowers seeking loans. These platforms typically screen applicants and serve as intermediaries. While P2P lending involves higher risk, it also offers the potential for substantial returns.
If you have extra funds and are open to exploring alternative investments, P2P lending might be worth considering. It allows individual investors to lend money directly to borrowers. Although the risk level is greater than that of traditional investments, the potential rewards can also be higher. Here’s a guide on how to get started with P2P lending, along with its benefits and drawbacks.
How Invest in Peer-to-Peer Lending Works
Peer-to-peer lending is usually facilitated through platforms such as Prosper and Upstart, which link investors directly with prospective borrowers. These platforms serve as intermediaries, managing the logistics of the lending process. This often involves
- Find creditworthy borrowers.
- Verifying their identification.
- Transferring funds
- Collecting repayment
In certain instances, the platform or an affiliated financial institution may initially fund the loans and then sell them to investors afterward. Lenders normally do not have direct contact with borrowers, and both sides’ identities are kept private. If everything goes as planned, borrowers will make their payments.
Should I Invest in Peer-to-Peer Lending?
Whether or not to invest in peer-to-peer lending is a matter of personal preference. Before stepping in, consider the pros and hazards.
Benefits of Peer-to-Peer Lending:
Potential for large profits:
P2P lending may allow for competitive returns. The International Review of Economics and Finance notes that between 2015 and 2018, LendingClub loans yielded a median return ranging from 4.7% to 10.3% for creditworthy borrowers. At the same time, Prosper reports an average historical return of 5.7%.
Low barrier to entry:
Peer-to-peer lending platforms may let you start investing with as little as $5 to $25, although some platforms may have higher minimum requirements.
Diversification:
Investing in peer-to-peer lending can help you diversify your portfolio while reducing risk. It’s an alternate investment that could be a useful addition to assets like equities, bonds, mutual funds, and exchange-traded funds (ETFs).
Risks of peer-to-peer lending
Risk of default: While most P2P lending sites evaluate borrowers, there is always the possibility of losing money. If a borrower defaults on a loan you funded, you could incur a big loss. Gains, like those from most high-return investments, are never guaranteed.
Fees can reduce your returns
Each platform has its own characteristics, though most charge a service fee. For instance, you might incur a 1% annual fee on each payment received from borrowers.
The platform holds funds
After funding a peer-to-peer loan, you will need to wait for it to be repaid before recovering your initial investment. That could be a problem if something comes up and you need money earlier than intended.
How to Invest in Peer-to-Peer Lending
If you want to get started with P2P lending, follow these steps.
Choose a Platform
Your investment goals will guide you in choosing the right peer-to-peer lending platform. For instance, Kiva focuses on providing loans to underserved communities.
Depending on your values, collaborating with this type of platform could be considered ESG investing. Meanwhile, many platforms may only work with accredited investors. This means
To qualify, you must have a net worth of at least $1 million, have earned more than $200,000 in the last two years, or have a combined income of $300,000 (if married).
When evaluating peer-to-peer platforms, define fees and investor requirements to determine the best fit.
Create an Account
Each platform works differently, but you’ll most likely create an account and then select which loans to fund. You may either do this manually or establish your preferences and let the site match you with potential borrowers. Some platforms allow you to automatically invest in loans that suit your specific requirements.
Stay on top of your Loans
Monitor your peer-to-peer lending account to check that borrowers are making timely payments. If you deal with a financial advisor, keep them informed so they can track your investment performance.
Depending on how things go, they may recommend adjusting your asset portfolio to reduce overall risk. They can also assist you in identifying your target borrower and loan size, estimating your average P2P returns, and assessing how it fits with your short- and long-term financial objectives.
Frequently Asked Questions
Is peer-to-peer lending safe?
Peer-to-peer lending carries more risk than traditional savings accounts or certificates of deposit, but it often offers much higher interest rates. While P2P platforms usually take on some risk, individual investors are generally the ones who shoulder most of it.
Is it worthwhile to invest in peer-to-peer lending?
P2P lending, like any other high-return venture, is not without danger. These loans have high default rates, which can result in losses for investors. Platform fees may also reduce any possible gains.
Do you need to repay peer-to-peer lending?
If you are approved for a loan, the peer-to-peer network may need you to pay an arrangement fee first. Then you repay the loan with interest by making regular installments during the term of the loan arrangement.
