5 Tips for Safe Peer to Peer Lending Investment

Jul 17, 2020 03:43 AM ET
5 Tips for Safe Peer to Peer Lending Investment

As bank interest rates dwindle by each fortnight, many are looking towards other modes of investments with higher-than-bank-interest returns.  This is where the concept of P2P Lending (Peer-to-Peer lending) comes in as a potential alternative. To this end, a thorough understanding of how P2P works and the risks involved therein is something worth knowing before venturing into it. 

How P2P Lending Works

The word ‘peer’ in P2P signifies that common individuals participate in such deals for mutual benefit. There’s less “middleman fee” on the P2P platform compared to regular banks. It allows borrowers to apply for loans at rates lower than what banks demand; and investors/lenders are also happy to lend capital with an eye to bag higher-than-normal returns which otherwise will not be possible through regular banking instruments.  Lenders though have to meet criteria like having a minimum income of $70,000 p.a. and/or $250,000 net worth. 

In P2P, an investor’s lending capital is always spread out into ‘notes’ of several smaller denominations, likely $25 each, allowing a spread of small investments across many different loan categories.

Tips for investing in P2P lending

It must be borne in mind that P2P loan value keeps changing with time like dividend stocks and bonds.  In P2P lending, you will collect your interest part earlier in the payback period and the principle is returned towards the backend of the payback. 

Diversify:  Another tool which is adopted in order to hedge investors is that the loaning opportunities carry various ratings/grades (let us take an example: Prosper has seven loan grades called Prosper Ratings:  AA, A, B, C, D, E and HR with AA having the lowest risk meaning they are the safest and HR having highest risk).  The higher the rating the less yield that you are going to be paid.  So, investing entirely in AA is not a good idea as it pays like 6.5% yield wherein you already have banks paying 2% to 3%.  Why would you want to take a risk on P2P lending which comes with a risk of non-payment from default borrowers? Similarly, investing in HR rating increases your risk exposure manifold.  Also analyzing a borrower’s credit profile, past credit repayment history, core business competency in terms of occupation, number of years of credit line, number of credit lines, number of delinquencies, debt-to-income (DTI) ratio, etc is very important before choosing to invest. 

Since an investor wants the highest amount of returns with the lowest amount of risk involved, choosing a C level and higher rating to diversity is worthwhile as it is seen to provide higher-than-normal returns with not very high risks involved.  In this way as an investor, you are willing to take on some risk in order to make a decent amount of money.  Here too you would want to remain diversified into various offerings and not commit all your spare funds into just a couple of deals.  The more categories you have in your kitty after proper research of their credit score, the lower risk involved for you.  This is simply because the likelihood of all borrowers defaulting together is uncommon.  Few recommended categories are debt consolidation, home improvement, auto, medical/dental, and sometimes others (for superb deals). 

Long-term mantra:  The tenure of the loan also is worth paying attention to.  It is advisable not to go for short-term investments.  You want to stay put for the long haul.  Terms of 3 years and above is relatively good and also provides a fairly good estimated monthly payment return.

Reinvestment: It is vital that a process of continuous reinvestment is followed to typically earn higher returns and ensure staying fully invested always. Always make sure you stay reinvested in order keep rolling your funds and ensure funds are not idling at any point in time.

Wise Selection:  The loan amount advisable is anywhere between $2K to $15K, because the lower the loan amount being borrowed, the higher the chances for an individual being able to pay off.  The higher the loan amount, the more likely they are going to default on it. 

Make sure that you invest with those who do not have any delinquencies whatsoever in the last 7    years.  Check their public records for the past 10 years.  Check if there are any inquiries in the last 6 months.

Look to loan out to people who are employed for at least bigger than 3 years with an income higher than $50k per year.  Entrepreneurs will have a tougher time repaying if their businesses do not perform well.  It is not a hidden fact that most business startups fail.  So you don’t want to risk that.

Use Various Platforms:  It is important that you use different platforms for investing and are not tied to just one.  A few good examples are Lightstream, Upgrade, Avant, Lendingpoint, Sofi, Lendingclub, etc.

Bottom Line

P2P Lending is a good investment option for those who can commit spare funds in order to avail higher returns.  However, staying invested in various asset classes like real estate, gold, stocks, mutual funds, as well as bank deposits in addition to P2P is always recommended to avoid putting all your eggs in one basket.  People with an eye for research and a stomach to experiment other avenues albeit with a touch of risk involved, can try P2P.  Are you one of them?

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