Peer to peer lending – A good alternative investment

//Peer to peer lending – A good alternative investment

Peer to peer lending – A good alternative investment

As a reader of this blog, I’m betting you and I have a similar approach to wealth and investing – Putting money into diverse investments over time, building our financial reserves, and carefully balancing risk and reward.

That means you’ve run into the same problem as me – In a 0% interest environment, where exactly do we put our money? I’ve been investigating peer-to-peer lending (P2PL), and I believe it’s an alternative investment that we can seriously consider. Before I get into the details of P2PL, let’s explore why many other investments just aren’t working right now.

  • The stock market – Since September 2015, the stock market has been extraordinarily volatile. Although that will smooth out over the long-term, if we want to invest for shorter periods we need to find better places for our money.
  • Bonds – Bond yields are very low. While bonds are part of any diversified portfolio, it doesn’t make much sense to put more money into bonds at the moment.
  • Certificates of deposit and savings accounts – The historically low interest rates mean that COD and savings interest rates are often sub 1%, which means you’ll get beaten by inflation, every time.

We need investments that will combine a reasonable reward with an understandable level of risk. Peer-to-peer lending can tick both of those boxes.

What is peer-to-peer lending?

P2PL lets investors like us lend money to borrowers via online lending sites. It’s called peer-to-peer because it doesn’t involve central banks or other financial institutions loaning money. It works on several key principles:

  1. It pools together money from many different investors.
  2. It uses credit ratings and other factors to work out the risk of lending to specific borrowers and the interest rates they’ll have to pay.
  3. It makes the pool of  investors’ money available to various borrowers, depending on your risk appetite.
  4. The borrowers repay the principal and interest at the agreed rates and terms.
  5. The principal and interest are returned to the investor, less a small fee for the P2PL service.

I think about P2PL as a good investment for the medium term. Typical loans run from two to five years, so you’re not tying up your money for extended periods. One of the best things about it is the regular monthly repayments of principal and interest which you can withdraw or reinvest in P2PL.

Because we’re lending to multiple borrowers for different lengths of time, there’s a constant turnover of loans and repayments.

What are the expected returns?

Fortunately, P2PL is not overly affected by underlying rates of interest. Instead, likely returns are based on the interest rate the platform charges to borrowers. That’s based on how risky they are, how likely they are to repay the loan, and certain other factors.

  • Loans to low-risk borrowers typically return 5-7%
  • Loans to medium-risk borrowers typically return 7-8%
  • Loans to high-risk borrowers typically return 8-10%

This means that $10,000 loaned over five years is likely to return the following amounts:

  • Low-risk borrowers: $12,850-14,200
  • Medium-risk borrowers: $14,200-14,900
  • High-risk borrowers: $14,900-16,500

These rates of return include borrowers that default on their debt (failing to repay some or all of what they’ve been loaned), so these are the expected overall returns that you can make.

What benefits can I expect from P2PL?

  • You choose the risk – Depending on the type of borrowers you want to lend to, you can choose the level of risk you’re comfortable with.
  • Your rate of return is not tied to the base rate – When interest rates are low, P2PL can still provide good returns.
  • Because money is pooled and lent out, it reduces the risk and exposure of individual lenders, meaning that if one particular borrower defaults the loss is spread out across many investors to minimize the impact.
  • The various P2PL platforms use factors such as credit history, credit scoring, salary, and various other factors to rate their borrowers so that you can choose who you want to lend to.
  • You get regular monthly payments on the capital and the interest.

What are the risks?

  • You can choose to lend money to more “risky” individuals; they will get a better interest rate, but with the possible downside of the borrower defaulting.
  • Diversify and reduce your risk by lending to a variety of different borrowers, and making P2PL just part of your overall investment portfolio.
  • P2PL isn’t available in all US states yet – You can find details on the various P2PL websites.

Where can I find out more?

You can invest in P2PL via various P2PL sites. Some of the more popular include:

My belief is that many investors should take advantage of P2PL as part of their overall investing strategy. As always, it’s vital to do your own research and think about the risk and rewards you want, but in a 0% interest environment, it’s definitely worth considering.

How can you use P2PL to meet your investment goals?

It’s time to review your financial goals.

Use P2PL if:

  • You want to invest for the short to medium term
  • You don’t mind an investment with some risk
  • You don’t want the volatility of the stock market or other more risky investments

You should be aware of the following:

  • As an investor, you can choose the risk profile of borrowers that you want to lend to
  • Your risk of default (not getting your money back) is spread out among many investors to reduce the possibility and impact
  • You will be taxed on the profit you make through P2PL

Actions

  • Review your life and financial goals
  • Identify your short to medium term goals
  • Review the terms, conditions, fees, and rates of return for the various P2PL platforms
  • Review the interest and default rates for various types of borrowers
  • Invest in P2PL for the timescales and goals you’ve identified
  • Review your P2PL investments on a regular basis (once or twice a year)

 

By | 2016-11-07T21:08:34+00:00 June 8th, 2016|Investments|1 Comment

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One Comment

  1. Captain Dividend June 8, 2016 at 6:11 pm - Reply

    I would like to give this a shot some time but I’m a bit worried about these lending sites as a whole being around for much longer. I’ve already heard of some shutting their doors as these firms are losing money hand over fist. Another thing is that if they go bankrupt, there are no assurances you will get your money back and I think only the cash in your account is insured, not the money you have loaned out. That’s the kind of stuff that scares me away.

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