Investors in peer-to-peer loans boast about getting double-digit returns on their peer to peer lending: 10%, 11%, even 20% on some platforms.
But of course, there are risks. This guide is written for those wishing to begin investing in loans.
What is P2P investing?
Peer-to-peer lending has seen high-yield seeking investors flocking to it. Primarily due to years of unpredictable stock market returns and low savings rates.
Peer-to-peer lending is where investors make unsecured personal loans to consumers. In return, they are rewarded with average annual returns ranging from 9 to maybe even 20% depending on the platform they use.
However, P2P lending is a risky investment and does contain risks to the original capital.
Peer-to-peer is essentially a financial transaction without the use of a bank.
Similar to banking, peer-to-peer lending is about offering loans to consumers and businesses with the interest derived from the loans paid out to investors, yet has cut out the bank as the ‘middleman.’
Rather than deposit savings into a bank that use the funds as loans to their customers. Peer to peer lending and investing is depositing your money into a P2P platform instead. The platform is then used to offer your funds to consumers as loans.
Usually, (although there are other ways to crowdfund) P2P lending is when borrowers apply through to peer-to-peer lending websites and complete a loan application stating the following:
- the loan amount
- the purpose of the loan
- general credit evaluation of themselves
This information is then made available to prospective investors, who decide which loans they wish to invest in.
Investor interest in peer-to-peer lending has rapidly grown. By 2050 the market is expected to be worth one trillion US dollars!
It’s easy to see why savings accounts are offering zero interest in customer funds. Peer-to-peer investing provides high-yield alternatives.
However, with anything offering a higher yield, there are more risks involved in your investment.
How can you minimise the risk to your capital when investing in P2P loans?
11 smart tips for P2P investing
1# Prepare yourself to accept some risk
The P2P investment market is young, and because of this, highly volatile.
Volatility, therefore, although it contains some risk, also means there is an opportunity for growth. Even if investors begin by depositing a low amount, they must acknowledge that it has some element of risk, and their capital could be at a potential loss.
The default risk is the borrower not paying back the money lent if they ‘begin to struggle financially. Most of the risk is minimised under Buyback guarantees and the Guarantee Fund.
If you do not want to have any risk to your capital investment, then investing in peer to peer loans is not for you. You have to accept there is some risk if you seek high returns.
2# Comparing P2P platforms
Before you begin investing in peer to peer loans, you will need to select a platform to deposit your funds into and determine which projects to invest in.
Some platforms are more specialists in individual loans types, others:
- pay higher returns
- have introductory bonuses
- have BuyBack guarantees and more innovative investing software to make investing easier.
Plus, you will want to know how you can withdraw funds and whether there are any fees? What are the project default rates or any early exit penalties?
These are all questions you need to check before deciding on a platform.
Ensure you use platforms that have a track record of having operated for a couple of years. It is useful to view the performance of the past platform projects to gauge their success.
Naturally, past performance offers no guarantee about future yields. However, platforms that have been operating for several years mean they have obtained market experience and historically been able to demonstrate returns, which are unlikely to be scam companies. They will also likely have reviews written about them.
3# Do your homework on any P2P scams
With all financial transactions and lending, there are risks. Sadly, peer-to-peer lending has seen a spike in fraudulent attempts to dupe investors and consumers out of their money.
A P2P lending scam happens typically when a P2P lending platform begins to block investors from withdrawing their funds and closes the site down.
Whether the P2P platform was created to defraud investors or closed due to mismanagement and lack of liquidity is often not known.
We’ve written a guide about P2P scams you can read here.
4# Know about P2P loan types
There are three main loan types: consumer loans, business loans and property (real estate) loans.
Business loan lending may have a personal guarantee from the business director(s), making it more attractive to invest. Property loans are secured on the property, making them more secure whilst consumer loans are lent to individuals. Consumer loans are often unsecured.
It is best to invest in all loan types to ensure that your risk is spread out. Also, check the payment history of individual loans, including the data held about the borrower. Knowledge is key to obtaining a higher yield if the borrower is trustworthy.
5# Understand and use secondary markets
Secondary markets are marketplaces on platforms like ours are where investors can buy and sell their investments if they wish to exit them.
If an investor wishes to exit a loan before the withdrawal date permitted, they can place their share of the loan on sale, and others can buy it or part of it through the platform.
Examine the payment history of the loan before buying it through the secondary market. Ensure it does not have any arrears or that it is due to mature soon.
Secondary market loans are a superb way to diversify your portfolio – you freely choose which amount of it to buy, thus minimising your portfolio risk.
Note that not all platforms have secondary market features, and some have limitations.
6# Diversify your portfolio
Diversification of your portfolio is a fundamental basis for any financial investing.
It is always a sound strategy to invest low amounts in varying projects, instead “putting all your eggs in one basket.”
A diversified P2P portfolio should include a variety of investment projects, for instance, bonds and stocks. If your investment portfolio is secured by real estate, then the risk to your capital is reduced even further.
Secured loans tend to have lower default rates, and the loan recovery process is a lot smoother than unsecured loans.
7# Use the AutoInvest feature
To maximise their investing rewards, investors should monitor their P2P accounts and keep the cash held on the account to a minimum.
One way to keep cash from being off the account is to use the AutoInvest feature, which is excellent for decreasing the amount of time needed to keep your investments ticking along.
Auto Invest works well when all the loan types and projects are similar, ensuring volatility levels remain uniform.
A platform with variable loan types with low and high-risk projects means that AutoInvest should be switched off and the projects managed manually.
8# Decide between investing in secured/unsecured loans
Consumer loans are mostly unsecured, meaning that they are riskier to invest your money in.
Business loans offer either none or some form of security, meaning there is some reassurance should the loan default that capital can be repaid. Some business loans come with personal director guarantees.
Property and real estate loans usually offer a first or second charge on the property as security, making them less risky.
Usually, it is preferable to have some form of security offered. However, even with property provided as security, there is still a risk that a loan could default. Plus the risk of property failing to sell at a price high enough to be sufficient for the full recovery of the principal of the loan.
9# Invest in different markets
A solid strategy in investing in P2P lending is searching for opportunities in other countries; it is all made easier if you use P2P software, making it quicker and more straightforward.
Investing in various markets across Europe is a solid strategy to diversify and build a robust portfolio. Plus, loans outside of your own country could bring higher return rates if the markets are newer.
10# Use platforms that have a BuyBack guarantee
A BuyBack guarantee is an agreement, usually a legal contract, between the loan originator and an investor to protect them against a borrower defaulting on the loans.
BuyBack guarantees activate when a borrower misses payments for a particular number of days. If this occurs, the loan originator is obliged to wholly or partly buy back the loan.
Buyback guarantees compensate investors for the remaining principal and some of the interest and penalty fees.
A buyback guarantee does not eliminate risk; it merely minimises it.
11# Start slow, very slow
As with all new financial ventures, newbies should begin slowly as they learn about P2P investing.
Start with smaller amounts, learn where it is easier to make returns, and incrementally increase your deposits. It is even better to reinvest your returns from existing projects into new ones to avoid depositing more funds.
Only when you are confident, then you can accelerate your investing. But for now, begin slowly.