P2P Lending

The Case for Peer to Peer Lending

The other day, my friend Lisa, mentioned she got a car loan. She was on her way out to shop for a new car when I rang.  Not unkindly, let me say that Lisa doesn’t have the best credit. Her ex-husband left her with mountains of debt and it’s been really tough for her. She’s been driving the same old car for years.

Although I didn’t want to pry into her personal finances too terribly much, I asked, “Where did you get the loan? I hope you got a good rate!”  She mentioned that she was able to get a car loan through a website, Ratesetter. I went online to check it out even while we were chatting.

Eureka! I thought. Maybe this is the idea I’ve been searching for. Unlike Lisa, I wasn’t interested in going for a loan but lending my capital to borrowers who will pay a reasonably high rate of interest.  My inheritance is so precious and investing it intelligently isn’t as easy as I imagined it would be a couple of months ago.  Maybe peer to peer lending could be a good option for me.

Crowd Funding

I already knew that Kickstarter is great for getting funding if you’re an inventor or entrepreneur. I’d also heard about GoFundMe for charitable causes or YouCaring for medical bills. There were little stickies up all over the hospital for parents in search of money for children’s medical bills. But I hadn’t heard about what’s called peer to peer (P2P) lending until my friend mentioned her car loan.

By now, you know I like to do a lot of homework before investing. I found a lot of positive reasons as well as some not so brilliant reasons to invest my money as a P2P lender.

What is P2P Lending?

In essence, P2P lender sites allow individuals like me—would-be lenders—to make loans directly to an individual or via loan pools. Individuals who need loans, like my friend, are more than happy to pay higher rates to get the money they need now.  There’s no need for a bank to stand in between us with these new lending / borrowing platforms.

I’m sure there are other good people out there who need money to buy a car. Traditional banks turn down good people with bad credit every day. The reasons they reject loan applications is far too confusing for me to recap here!

The good news is that technology allows P2P lenders to completely cut out banks as the middle man.  This means, as I lender, I can lock in a higher rate of return on the loan.

Borrowers can also save money. If the borrower has bad credit and ends up getting a pay day loan, it’s going to cost more than a P2P loan in most cases.

P2P loans are going to cost the borrower less than the interest charged on credit cards. Have you researched annual percentage rates on most cards issued to people with bad credit?

Pros of P2P Lending

There are more positive reasons to become a P2P lender than reasons to avoid taking the plunge:

  • I’d get a higher than typical rate of interest relatively to a bank deposit or corporate bond.  Most P2P loans usually pay double digit interest rates.
  • I’d help people in need.  I’ve been in tight spots financially before and would have loved to have had the P2P lending option in the past.
  • I’d have the choice to diversify my risk across a portfolio of loans, often 100 or more, so that if an individual defaulted on a loan the overall impact to me would be small
  • I’d have the choice of the types of loans to invest in, including consumer, business, livestock, etc.
  • I’d have the choice of loan term, usually two to five years
  • I’d have the option of selecting a loan portfolio that matches my risk appetite
  • I’d also have the ability to sell the loans early if I needed cash.
  • I might have access to loan insurance as some P2P lending businesses provide this.
  • What’s more, P2P lending doesn’t seem labor or time-intensive. I wouldn’t need to learn about and monitor stock or forex investments. I wouldn’t need to deal with potential headaches and operational issues of a vending machine or kiosk sales business.

After putting my money to work, I could spend free time with my kids!

Cons of P2P Lending

Of course, there are more than a few reasons to be cautious.

I’m old enough to remember the global credit crisis of 2008 and P2P lending is a relatively new business idea. P2P lending hasn’t been put through a large scale recession yet. If borrowers lose jobs in higher numbers than today, I don’t know what the loan default process would be like.

I’m unclear about how accurate borrower data is on any P2P loan site. How much information and due diligence is performed to get lenders the money they need within a reasonable time?  My friend got her loan offer in a matter of days so I’m not sure how thorough they are.

I don’t know about P2P lending platforms’ regulatory oversight.  How closely is the government looking through their business practices and lending procedures?

The loan servicing fees of 2 percent seem kinda high.  Although banks probably charges a lot more, these fees aren’t insubstantial.  It’s a nice return for just connecting borrowers and lenders without risking thier own capital.

Conclusion

Some of my friends who have an interest in investing have been chattering away about portfolio diversification. In simple terms, this means don’t put all your eggs in one basket.  After considering the peer to peer lending option, I’ve decided to allocate only a small portion of my portfolio to P2P lending.

I haven’t decided which P2P lender to choose or the kind of loans I want to take on. There are many platforms to choose from, so I need to focus my research brain on which is best. Here are some of the facts and figures I’ve found so far:

  • Ratesetter reports 3,995 investors with 56.4mm of loans with a 0% default rate thus far.
  • Marketlend reports 980 investors with an average rate of 11 percent on 7.2 mm of loans.
  • Societyone has underwritten about 100mm of loans since 2013.  They also co-invests at least 2.5 percent in the loans from their platform.

Yes, P2P loans seem fantastic—but I’m not going to put 100 percent of my inheritance here. I’m going to diversify my portfolio to take advantage of ever-cyclical market conditions.

What do you think? Have you invested in P2P loans or do you know anyone who got a loan from a P2P lending business? Please share your thoughts!

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