Are you tired of lackluster interest rates? Concerned about the record highs of the stock market? Searching for an easy way to diversify your portfolio into alternative investments and achieve solid returns?
If you answered yes to any of these questions, then peer-to-peer lending may be an investment strategy worth considering.
What is Peer-to-Peer Lending?
Peer-to-peer lending (or P2P lending) allows you to loan money directly to borrowers. It effectively cuts out the middleman – the bank or lending institution.
Lenders (individual investors) and borrowers (typically smaller companies or individuals) come together online via a P2P lending company or platform.
For borrowers, P2P lending offers several advantages over traditional lending practices:
- competitive interest rates
- less paperwork
- faster decisions for approval
This relatively new market is growing rapidly. PriceWaterhouseCoopers estimates the P2P lending market could reach $150 Billion by 2025. That’s Billion. With a B.
How Do You Invest in P2P Lending?
Starting to invest in P2P lending is simple. You only need to:
- Choose a P2P lending platform
- Open an account
- Deposit funds
- Begin reviewing potential borrowers
Each P2P lending site outlines the qualifications and procedures to start. The required minimum investment (which can be as little as $25) varies by platform.
After reviewing the profiles of potential borrowers, you decide which borrowers to lend your money.
A profile includes detailed information about each loan, such as the:
- interest rate
- reason for the loan
- term of the loan (typically 2 to 5 years)
- risk assessment (or grade) of the loan
With each loan, you can choose to fund none, some, or all of the loan. Once the loan is fully funded (usually by multiple investors each loaning a portion of the requested funds), the borrower begins to make payments on the loan.
You can decrease risk by investing small amounts into multiple loans rather than investing a large sum in one loan. This also helps diversify your investment into different grades of loans, with different terms of maturity.
As each payment on the loan is made, a portion of the payment (which consists of interest and principal) goes back to each of the individual investors involved with the loan. The profits are available for you to reinvest in other loans or cash out.
Each P2P lending platform charges a small fee for investors. These fees vary by site. With hundreds of loans available at each of the lending platforms, it’s easy to get overwhelmed. So, each site offers you the option to manually select the loans or automate the process.
This automatic option allows you to select the criteria of the loans of interest to you (risk grade of the loan for example ). The platform automatically invests the amount you specify into the loans meeting your criteria.
Who Are the Major Peer-to-Peer Players?
The oldest peer-to-peer lending platform in North America is Prosper. According to the Prosper website, it was “founded in 2005 as the first peer-to-peer lending marketplace in the United States. Since then, Prosper has facilitated more than $12 billion in loans to more than 810,000 people.”
In 2007, Lending Club launched and their site states “over the last 10 years, we’ve helped millions of people take control of their debt, grow their small businesses, and invest for the future.”
Prosper and Lending Club are by far, the largest P2P lending sites in North America. However, with the growing popularity of P2P lending, other players are joining the market. These include Upstart, Funding Circle, Peerform and Lending Loop (in Canada).
What are the Advantages of Investing in P2P Lending?
- Help support small businesses or individuals by lending money
- Start investing with a small dollar amount
- Customize loans (amount of loan, risk level, term, etc.)
- Diversify loan portfolio by spreading money into multiple loans
- Achieve higher yield than currently available (through savings accounts, CDs, etc.)
- Automate your account so that you don’t have to review individual loan requests
What are the Disadvantages of Investing in P2P Lending?
- Risk losing money (potentially all your principal) if borrowers default on loans
- Principal investment is tied up for the full term of the loan (typically 2 to 5 years)
- P2P lending has not been long-term tested in the marketplace (has gained popularity within the last 10 years)
- Investment is not FDIC insured
- Qualifications/restrictions vary by lending platform and permanent residence of investor (some platforms do not operate in all states)
Is P2P Investing a Good Way to Make Money?
Although it’s relatively new, P2P represents an opportunity for individual investors to jump into the lending process. A process that has historically been unavailable to anyone other than large institutional investors.
As with any investment, you should carefully consider the risks and rewards before you invest.
If you decide to invest, peer-to-peer lending can provide you with healthy returns and a reliable income stream (as loans are repaid) and help diversify your portfolio.
Article written by:
Cindy, a Women Who Money guest contributor, a former aerospace engineer, blogger of personal finance, wife, and mother of 3 teenagers. Although American citizens, Cindy, and her family currently reside in Canada. You can read about her AmeriCanadian life and her family’s quest for financial independence at Dash2Retire.com.