Peer to peer lending, also known as p2p lending, was established in 2005 in the UK as a form of social lending that directly connects investors with potential borrowers. Many investors consider it an excellent alternative to traditional lending because it usually offers high returns. However, this lending also carries some risks that you must consider before investing money in it. Here is everything that you need to know about peer to peer investment.
What Is P2p Lending?
It is a type of financing that allows individuals and small businesses to get quick funds from investors without involving any middleman or financial institutions like banks. It is sometimes also referred to as social lending or crowdlending.
With p2p lending, investors can use online platforms or sites to lend money and fund full or partial loans. In return, they can get high-interest rates compared to standard bank loans. In addition, these platforms set the loan terms and rates in advance. Typically, these rates and terms are more suitable for both the investors and borrowers than conventional lending methods.
Individuals who find it challenging to secure a loan from banks or traditional lenders due to bad credit scores can go to p2p platforms instead. These platforms act as intermediaries and handle everything from underwriting to transferring funds and getting repayments. It makes the lending and borrowing process simple and straightforward for all the involved parties.
P2p platforms usually consider several factors before lending money to a borrower, such as borrowers’ credit scores, income, credit history, debt to income ratio. On the basis of these factors, the lenders decide the terms and rates of loans. If we see from the investor’s side, these platforms provide an excellent opportunity to diversify their portfolio for potentially higher returns compared to other high-yield investments.
Things To Look In A P2p Platform
Since the formation of this financial sector, many platforms have evolved to provide an alternative financing method that has proven to be beneficial for investors and borrowers. Unfortunately, although there are numerous p2p platforms, old and new, it can be difficult for you to find the best one to invest your money in.
When you are choosing a peer to peer platform, you must consider the following things:
Maximum & Minimum Loan Size
When choosing a platform, you should look for the loan size because many platforms set a minimum and maximum loan size. Moreover, they may put a cap on loans which can limit your profit. Therefore, you should invest money through a platform that allows you to invest in larger loans.
The most significant risk in p2p investment is the risk of default, leading to losing all your money. So, it is essential to look at the default rate when choosing a platform. Many platforms display the number of default rates in their statistics, making it easy for investors to select a low default rate platform.
Peer to peer platform scarry out several checks when screening borrowers. Some platforms have minimal requirements for borrowers that can increase the risks of defaults. You should always look at the security checks of the platform to ensure that your money will be safe. The best platforms consider borrowers’ credit score, income, financial history, and affordability to repay the loan.
Full or Partial Investment
Some platforms allow multiple investors to pool their investments together to fund a large loan. While others do not allow partial investment, and you have to fund a complete loan.
Most p2p loans range from two to five years, and you will get repayments in monthly or weekly installments. You should set your investment goals and lock your money according to them.
Average Return Rate
The rate of return varies from platform to platform. Therefore, you should shop around and search for a platform that offers competitive rates and follow the best lending practices. Usually, the average returns range between 7-11%.
Peer to peer lending UK platforms earns money by charging investors and borrowers fees. For example, some platforms charge 1% fees from their investors. Other fees include origination and early repayment fees that are charged from the borrowers.
P2p sites also set criteria for investors. For example, sometimes, you are not able to start investing until you have a certain income.
You should always choose a platform that allows you to diversify your portfolio—some platforms deal with a single type of loan while others offer a variety of loans. You should invest in different types of loans and spread capital across multiple borrowers to reduce risks.
How To Invest In p2p Loans?
You should always start by searching different p2p platforms that are present in the market. Then, compare these platforms in terms of interest rates, average return on investment, fees, and default rates. You can also read online reviews to find the transparency of a platform.
Once you choose a platform, create an account as an investor and deposit funds. T takes only a few minutes to complete this process. Some platforms ask for some necessary information such as your expected interest rate, loan terms, and the amount of cash you want to invest.
Then spread your capital across multiple small loans instead of investing all your money in a single loan. It reduces the risk of losing money if a borrower defaults on a loan. You should always invest an amount according to your risk tolerance or that you can afford to lose. Choose the loans you want to fund and invest your money. You will get the loan amount plus interest rate in monthly instruments.
Pros Of P2p Investment
Here are some significant benefits of p2p lending:
- You can earn higher returns on investment compared to conventional investment options.
- Since there is no middleman or financial institution, almost all the profit comes to your pocket directly.
- Most platforms evaluate borrowers’ creditworthiness and affordability that reduces the investors’ risks.
- You can invest in p2p loans through IFISA and earn interest within a tax-free wrapper.
- You can diversify your p2p investment portfolio and choose multiple borrowers to minimize risks.
- Many p2p platforms also offer contingency funds to cover the defaults.
Cons Of Peer to Peer Investment
P2p lending can be a worthwhile investment, but it also has some drawbacks that you should keep in mind.
- The borrowers may fail to repay the loan. The more the default rate of a platform, the more will be the risk for investors.
- Early or late repayment can affect your profit.
- The p2p platform can go out of business resulting in a significant loss of money.
- The income from p2p loans is usually taxable.
- Usually, the money invested in a loan is illiquid till the loan terms end.
- There is no protection by the Financial Services Compensation Scheme (FSCS).
Now that you know all the essential things about peer to peer investment, it can be easier for you to decide whether you should invest in it or not. Overall we can say that peer to peer lending is an excellent alternative investment, and you can earn high returns by taking appropriate measures to reduce risks.