Peer-to-peer or P2P lending has become a popular means for investors to get the most out of their money. The popularity has grown in recent years as the rates of savings and bonds have become disappointing. With P2P platforms, investors provide unsecured loans to consumers. In turn, investors get an average annual return of 7, 9, or even 11%. However, just like any other investment peer to peer is risky.
P2P is non-bank banking. Similar to banking, p2p makes loans and returns the proceeds of loans to investors/lenders. But P2P lending removes the ‘middleman’, a banker. Instead of investing through a bank in funds or certificates of deposit, you can invest in loans that are taken out by borrowers over peer to peer platforms.
For instance, as a borrower, you can go to a P2P platform online and fill out an application for a loan. You only have to provide some necessary information like the purpose of the loan and loan amount along with a general evaluation of your credit. The information that you provide is given to the potential lenders who can then choose which loans they would like to invest in.
On a typical P2P website, a consumer can borrow up to £20,000 as an unsecured personal loan. Usually, the loan term can be between three to five years. Further, the loans are priced depending on credit grades. Often there are around a dozen grades. The grades are based on the following factors:
- Borrower’s income
- Borrower’s credit score
- Loan purpose
- Loan amount
- Loan term
Contrary to belief, on the credit side, the majority of peer to peer platforms don’t handle subprime handles. The credit score has to be at least 600 or more. Also, p2p sites don’t offer loans to people who have recent tax liens, judgments, or bankruptcies. The best thing about peer to peer is that all the administrative tasks regarding loans such as underwriting, closing, distributing loan proceeds, and collection of payments monthly all is managed by the platform. All the monthly payments are remitted to you on each loan. This means that all you have to do it choose the loans you want to invest in, sit back, and collect your payments on each loan.
Benefits of Peer-to-Peer Loans
Investors’ interest in p2p lending has grown a lot over the last few years since it offers a high-yield alternative along with other benefits.
Create Your Portfolio
On P2P lending platforms, you have better control over the investment specifics compared to other forms of investment. You can choose borrowers based on specific criteria like loan type, term, credit-score range, and debt-to-income ratio. This way, you can manage the variables around your individual investments. Now, most peer-to-peer platforms provide services that can automate this whole procedure for you.
High Rates of Return
Most P2P lenders report investment returns of more than 10% annually. This isn’t a surprise since the typical loan rates provided by the platforms range between six to 36%. A portfolio with blended credit grades can earn double-digit returns easily, even after you subtract the one percent management fee and the allowance for loan defaults.
Personal Savings Allowance
The interest that you earn through P2P lending gets included in your Personal Savings Allowance (PSA). Currently, this stands at £1,000 interest for people who pay basic-rate tax and £500 individuals paying higher rate tax.
Peer to peer lending allows you to spread your funds across multiple loans. This way, you can manage the risk in a better way. For instance, if you spread £5000 over a hundred loans and one loan gets default, then your potential loss will be £50. But, if you spread that £5000 over ten loans and one gets defaulted, then you will lose £500.
Risks Involved in Peer-To-Peer Lending
Unsecured Loans That Can Default
P2P loans are made to individuals and are a risky investment. The risk is increased because the loans are unsecured and the platforms offer no collateral in case the loan defaults. You may lose all your investment in the event of early-term default.
Funds Are Not Lent Right Away, So You May Not Earn Interest for a While
You cannot earn any interest until your money gets lent. It can take some days to find the right borrowers depending on the platform, primarily if you are investing a large sum, it can take much longer time to be lent out.
You May Not Get Your Investment Back
While most peer-to-peer investments work well, there still is the primary risk of not getting repaid if borrowers fail to pay back the loan. Every P2P platform has a way of lessening this risk, so you have to ensure what kind of provisions a site has in place before you decide to invest.
No Guarantee of Safety
With the standard UK savings account the Financial Services Compensation Scheme (FCSC) provides a level of protection. It pays back the first £85,000 of the saved funds, per financial institution in case the platform goes bankrupt. Any funds that you have invested with a peer to peer are not backed up by FCSC.
Difficulty in Getting Your Money Out Early
A lot of peer to peer lenders allow you to withdraw your money early, by matching all your existing loans with new lenders. While the technique works well, you may have to wait for several months before this happens.
We have enlisted all the risks that you must be aware of before investing in peer to peer lending. The great thing about the P2P platform is that it works for everyone since there is so much choice. You can either go with a hands-off approach to get a predictable and decent interest rate, or you can get involved and have more control over the amount of money that gets used.
If you are looking for an alternative investment, then peer to peer lending is a good way to start because it requires a minimal effort and you don’t need any in-depth knowledge before investing. You can just put your money in and check the balance every month.
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