Peer to peer lending is an innovative way for individuals and businesses to secure the funds they need, given it’s P2P nature there is a huge demand for individuals and businesses to loan out capital in exchange for a return rate (typically far beyond commercial savings products). However, there are significant advantages and disadvantages to consider for those looking to lend money through a P2P site.
Pros
- Liquidity – It’s relatively liquid, meaning your funds are relatively easily accessible. If you invested the same funds in property, it could take months or even years to sell the property and get your money back. Of course, it’s not as liquid as keeping your money in a bank where you can withdraw it at any time, but the balance of liquidity and high returns makes it a favourable option for many savers.
- Diversification – P2P lending is a way for investors to diversify their investment portfolio by investing outside of stocks and bonds.
- Ethical Nature – Many investors feel that it’s a more ethical way to invest funds by helping others access seed money for business ventures, or much-needed personal loans when banks have denied them funds.
- Beating the Market – Interest rates have been at a record low on savings accounts in the last few years. This low-interest-rate environment has led to a spike in peer to peer lending, as savers look for better returns on their savings. Peer to peer lending is an effective way for people to save their money with a far higher interest rate as, without the overheads from a middle person such as a bank, peer to peer investors can earn higher interest rates.
- Improving Safety – Peer to peer lending is arguably getting safer, as platforms carry out stricter credit checks. Investors also have the option to split their funds into smaller amounts lent out to multiple borrowers to reduce the risk of losing everything to one defaulting borrower.
- Guarantees Becoming More Common – Many sites have also introduced their own contingency schemes which assumes the risk of a defaulting borrower by guaranteeing to return an investor’s full savings if a borrower doesn’t pay up. Sites create this fund by charging a credit rate fee to each borrower between 0.5% to 3% of the loan, which contributes to the provision fund. These schemes encourage investors to use peer to peer lending by reducing their risk of losing their funds.
Cons
- Not Savings – Many lenders view peer to peer lending as a form of savings. This perception can be dangerous, as peer to peer lending does not come with a safety guarantee. It should be viewed and treated as an investment, with the necessary caution, as there is always the risk that you could lose all of your money if your borrower can’t pay. As there’s no intermediary party, you are exposed to much higher risk if your borrower defaults.
- Risk of Being Up Sold Risk – Savers are attracted by the high-interest rates, and many get persuaded to lend to higher-risk borrowers owing to the higher rate of return. The higher the borrower’s risk of defaulting, the higher your risk of losing your money, too.
- Default – Another risk to consider is whether your borrower repays your funds either early or late, which can damage your profits. If a borrower repays your loan early, you can lend the money out again through the website to a different borrower, but there is always the risk that you aren’t able to lend out at the same interest rate.
- Not Instant – It can take time for the company to lend out your funds, and you won’t accumulate any interest in this period. This is something to bear in mind for significant investments, when it may take days to lend it all out.
- Locked in Minimum Period – There may come a time where you need the savings that you’ve invested in a peer to peer lending platform, particularly as one- to five-year loans are the standard. If you withdraw your funds early, some schemes charge a significant early-withdrawal fee. On some platforms, you may not be able to remove your money at all during the loan term. You may be able to sell the loan on to release your capital, but you will also incur a fee for this, and it may take more time than you can afford to wait.
- Target Vs Real Returns – Another thing to watch out for is that the rate lenders quote is not always guaranteed. Peer to peer lending companies will quote expected returns for investors, perhaps referred to as projected or target returns, but the actual rate you get could be less. A borrower might repay your loan early, or not at all, and if there’s no provision fund to cover the non-payment, then you could lose some of your investment.
- Less Compared to Traditional Investments – There’s less liquidity than stocks or bonds owing to the extended loan terms, usually between one and five years.
- Early Days, Risk Still Remains – Lastly, peer to peer lending is still a relatively new phenomenon, only coming onto the scene in 2005. In May 2019, Lendy, a mid-sized peer to peer lending platform, collapsed, costing 9,000 investors up to £90 million. Lendy collapsed despite regulation by the FCA, demonstrating the unpredictability of the industry and the risk to investors.
Maximising Returns
While you’re looking for a peer to peer funding platform to use, there are plenty of things to consider. Bear in mind the following when making your decision:
- Focus on the platform, rather than the loan: P2P lending is one of the less time-consuming investment options. If you’re looking for good returns for minimum effort (beyond research), opt for platforms with a good reputation and track record.
- Diversify your investment: Just as putting all your eggs in one basket leaves you vulnerable to a defaulting borrower, the same goes for the number of platforms in which you invest. If you split your savings across several platforms, you reduce your risk if one of the platforms goes bust. That said, it can be hard to keep track of your funds when they’re spread across too many platforms, so investors recommend sticking to a maximum of five.
Written by
Editorial Team
