If you’ve been looking up the words peer-to-peer loans or microloans on Google of late, it is likely you are in search of options that will yield higher returns on your investments because you’re too tired of the traditional products that offer low interest.
Although Peer-to-Peer lending is an alternative asset, you must learn more about how it works and what risks and rewards it involves before taking the plunge. Additionally, find out whether or not investing in peer-to-peer lending is a good option and worth your time.
What does P2P lending mean?
You become the bank for someone else when you invest through peer-to-peer lending. You create investment portfolios of unsecured loans that can potentially earn you anywhere between 4% – 9% annually in returns.
it gets a lot easier to offer loans to more than one person through trusted P2P lending platforms like Lendee, where you can earn faster and greater returns. Besides, you get to spread your investment into slivers of loans to minimize any risks.
Another benefit of using a microlending platform is that you can loan money only to high-rated borrowers if you don’t want to take too much risk. You can also diversify your investment portfolio based on the loan type, size, duration, term, and geographic concentration.
Most experts advise following the 80:20 rule, according to which you place 80% of your peer-to-peer investments with high-rated borrowers and 20% with low-rated borrowers. Also, achieving outstanding loan diversification is much easier with microlending platforms since they are technology-driven.
What makes P2P lending so popular?
Some of the reasons are:
- Microlending platforms typically offer more economical and faster services compared with traditional banks.
- Opportunity to earn higher returns on investments.
- Several P2P lenders pass many savings onto borrowers at lower rates and fees.
- Ease of investing any time from anywhere.
- The peer-to-peer market, on average, grows more than 40% a year.
If you’re still getting worked up about whether or not you should invest in P2P lending, don’t! It is a fully recognized and legitimate way of investing and is regulated by the Securities and Exchange Commission (SEC). The commission’s focus is to protect lenders or investors through disclosure requirements.
The SEC considers P2P lending investments as securities, and that’s why they are subject to a host of rules, such as Rule 415 of the Securities Act of 1933, the JOBS Act, and the Blue Sky Laws of state securities regulations.
How does P2P lending work?
- Loan amount they want to take out
- Purpose of the loan money
- Loan term or the payback period
- Income, debt, and bankruptcy history
- Credit score
There are multiple peer-to-peer lending platforms, but not all accept borrowers with bad credit. However, it is different with Lendee. No matter what your credit score is, with Lendee, you can be sure to receive a loan at a fair rate.
Risks of P2P lending
Investing in P2P lending comes with its share of risks. Here are a few:
- Higher likelihood of defaults – The most significant risk for investors is when borrowers fail to pay their loans. So, if a borrower defaults early in their loan term, you may lose your investment. But, if the platform goes out of business, you can lose all your money. Hence, use only trusted lending apps or the ones you’ve done a background check on.
If you’re wondering what happens when a borrower defaults, well, the P2P lending platform sells the defaulted loan to a third-party collection service at a fraction of the original amount, potentially wiping out the value of the loan.
- Platform reliance on stated vs. verified income – Not all P2P platforms verify borrowers’ information, and they also don’t take responsibility for making credit decisions. So, always carefully select loans with verified incomes to minimize your risk exposure.
- Illiquidity – Your money is invested for a specific loan term, although each monthly payments earn you some principal and interest money. But, you could land in a tight spot if a borrower makes late payments.
You may be able to sell your loan at a substantially lower rate on the secondary market if you want to unwind your position early, but don’t forget that P2P investments are illiquid.
Rewards of P2P lending
Investing in P2P lending also has its share of rewards, some of which are:
- Higher and faster yields
A newly issued report by Morgan Stanley shows that yields on P2P loans outsized credit spread and may provide a cushion against realized principal loss when investors face adverse economic situations.
- Investment diversification opportunities
One of the biggest perks of P2P lending is that you can invest in portions or slivers of multiple loans. These can be as little as $25. For instance, you can diversify your $1000 investment by spreading it across forty loans, and that’s without raising costs or default risks.
- Freedom to set your own terms and fees
P2P platforms like Lendee give you complete control to set your own terms and fees. Furthermore, you don’t have to split your earned interest like you would on other lending platforms.
How to balance the risks involved with P2P loans (a.k.a microloans)
Let’s assume you have $10,000 to invest for three years in two different fixed-income portfolios. Here’s how your returns will look:
Portfolio A (traditional fixed income portfolio)
You place $5,000 each for three years in U.S. Treasury at 0.18% and in a bank CD at 1%. You’ll earn $27 and $150 from both investments, totaling $177 or 0.59% annual return. (Keep in mind they are liquid investments).
Portfolio B (traditional fixed income portfolio with a P2P investment)
You place $1,000 of those $10,000 into a well-diversified P2P lending investment that yields returns of 10% after fees. For instance, 10% of the $1,000 ends up in default, sweeping out $100 of your investment. Yet, you’d have $900 in P2P investment earning you 10% per year. That’ll earn you $270 over three years, turning your original investment of $1,000 into $1,170. (Keep in mind that part of the investment was illiquid).
Your $9,000 investment in government securities ($4,500 at 0.18%) and bank CDs ($4,500 at 1%) will earn you $159.30 over the same period.
Therefore, Portfolio B’s combined three-year return comes to $170 from P2P investment plus $159.30 from the government Treasury and bank CD. That sums up to $329.30, 86% greater than Portfolio A’s $177.
|Fixed Income Portfolio A |
$10,000 Divided As Follows
|Fixed Income Portfolio B |
$10,000 Divided As Follows
|$5,000 in three-year Treasury (at 0.18%)|
$5,000 in bank certificate of deposit (at 1%)
|$4,500 in three-year Treasury (at 0.18%)|
$4,500 in bank certificate of deposit (at 1%)
$1,000 in P2P (at 10% with 10% default rate)
|Three-year cash return of $177 or 0.59%||Three-year cash return of $329.30 or 1.10%|
Is investing in peer-to-peer lending a good option?
Investing in P2P lending with other securities can diversify your portfolio and significantly raise your returns while minimizing risks. You don’t need to be intimidated by the loan selection process because advanced microlending platforms like Lendee can guide your way.
So, why wait? Start investing today with Lendee and receive your payments automatically while you sit back and relax.
Download the Lendee app now to get exciting offers.