Peer-to-peer lending is essentially a matching process for borrowers with fund requirement with investors who have surplus cash. The entire matching process is done on an online platform. Peer-to-peer lending has witnessed substantial growth every year and according to a top consulting firm, it will grow to become a $150 billion sector by the year 2025.However, investors need to know about certain aspects, including risks, and they should not be swayed by the high return on investment that is projected as the top attraction of P2P lending. Here’s what to keep in mind:
Loan Requirements Can Differ Widely in Nature
P2P lending enables retail borrowers to get relatively small loans without having to face the bureaucratic systems in traditional banking. Loan applications may be posted for buying gadgets, making home improvements, undergoing medical treatment, to set up a small business, student loans, etc. As an investor, you can stick to lending to only customers for a particular requirement or broad base your investment portfolio by lending to customers with different needs, different amounts, and different tenors.
Risk Goes Up with the Return on Investment
Like any other lending scenario, the perception of risk drives the rate of interest in P2P lending. The platforms generally look into a variety of factors like credit score, employment history, employment sector, education level, etc. to classify borrowers into distinct risk classes. The grading enables investors to make their lending decisions more rationally. To make lending to the riskier customers worthwhile, investors will charge a higher rate of interest just like the banks do. Grading scales vary from one platform to another but all of them have a system in place to help investors make a better-informed decision.
No Guarantees against Default
There is no assurance of any borrower not defaulting on a loan extended through a P2P platform. Investors should know that the risk they assume when giving out a loan is totally their own and platforms will not cover defaults. The loans to are not insured so it is quite possible for investors to lose their money when lending. Many platforms, like libertylending.com, however, will work with investors to recover the money from defaulting borrowers.
It’s Not Necessary to Advance the Entire Loan Amount
An individual investor can limit his exposure to a particular client by choosing to fund partially. Multiple investors can pool the funds to meet the total loan requirement. Normally, however, the platform will set the lower limit of individual contributions. Making partial contributions is a good way for investors to diversify their risk so that even the inevitable default will not hurt as much.
Before signing up as an investor, you should know the various types of fees that the platform will charge you. The impact of the fee will reduce your ROI. Since P2P lending is relatively new, it is not clear what the impact of a downturn will be, however, the industry is well regulated by the government and either the SEC or the state regulator may be referred to in case of need.