In August 2000, Fortune magazine published “10 Stocks to Last the Decade.” By December 2012, the portfolio in question lost 74.3% of its value.
Of all the mutual
Based on these statistics, it’s obvious that investing is a risky business.
Investing in the stock market can still prove to be lucrative with the right expertise and budget, but many Americans lack both.
Peer-to-peer lending provides an alternative to traditional investing that doesn’t require an extensive knowledge base nor large budget. It also provides much greater returns than traditional savings accounts, among other benefits.
Sounds great, sign me up! But what exactly is peer-to-peer lending?
Peer-to-peer lending, also known as P2P lending, is a technology-enabled system where individual investors fund loans (or portions of loans) to individual borrowers. Essentially this cuts out the “middle man” or the bank.
Keep reading to learn more about lending clubs and why you should try them.
How it works
Peer-to-peer lending differs from bank loans in several ways. When you get a loan from the bank, the bank will use some of its assets, which are the deposits made into accounts by other customers, to fund the loan. With peer-to-peer lending, borrowers are matched directly with investors through a lending platform.
Investors select which loans they want to fund which are generally personal loans or small business loans.
Some marketplace lenders place restrictions on what types of people can invest in their loans. Some companies, such as LendingClub and Prosper, are open to everyone, as long as you meet the account minimums.
Other companies may only be open to accredited investors or qualified purchasers. Individuals are considered accredited investors when they have a personal income of $200,000 ($300,000 for joint) for the last two years, or a net worth exceeding $1 million, either individually or jointly.
Qualified purchasers must meet even greater requirements than accredited investors, owning at least $5 million in investments. Finally, some marketplace lenders are only open to institutional investors, such as hedge funds, commercial banks, pension or endowment funds, and life insurance companies.
The process is very straightforward. All transactions are carried out through a specialized online platform. The steps below describe the general P2P lending process:
- A potential borrower interested in obtaining a loan completes an online application on the peer-to-peer lending platform.
- The platform assesses the application and determines the risk and credit rating of the applicant. Then, the applicant is assigned with the appropriate interest rates.
- When the application is approved, the applicant receives the available options from the investors based on his credit rating and assigned interest rates.
- The applicant can evaluate the suggested options and choose one of them.
- The applicant is responsible for paying periodic (usually monthly) interest payments and repaying the principal amount at the maturity.
Peer-to-peer lending is still a relatively new method of investing and borrowing, but it does have a decade of history to explore.
The first company to offer peer-to-peer lending was Zopa, a UK company that has since issued more than $2.9 billion in loans since it was founded in February 2005.
In the US, this new method of lending started in San Francisco in 2006. Prosper launched in February 2006, followed by LendingClub. Now the largest peer-to-peer platform in the world, LendingClub started as one of Facebook’s first applications.
Before 2008, P2P lenders had fewer restrictions on borrower eligibility, and their offers weren’t registered as securities. This changed in 2008 after the Securities and Exchange Commission (SEC) intervened, citing the need for compliance with the Securities Act of 1933.
This led to major changes in the P2P space. Lenders were required to register with the commission, which kicked LendingClub out of action for six months before it could be reactivated. Various other companies completely left the market. Zopa’s CEO stated that registering with the commission was the key reason their company did not expand to the United States.
In 2008, the US found itself deep inside the global financial crisis. When the banks weren’t willing to lend money, borrowers began turning to peer-to-peer platforms. Even those who were able to borrow from traditional banks found better deals from P2P lenders. Investors, shying away from the volatile stock market, saw P2P platforms as less risky.
This mindset continues today, with prime and subprime borrowers able to access credit for more competitive rates and investors willing to provide them with the funds.
Benefits of peer-to-peer lending
Lending Club investing offers a range of benefits. The major benefit is the higher interest rates on offer. Many people use P2P as an alternative to traditional investments, like stocks and shares. While others may use it as an alternative home for their cash savings which earn very little sitting in their bank account.
Here are some primary benefits associated with peer to peer lending
1. Greater Returns
Investing in P2P consumer loans can yield 8% to 13%. Higher returns can also be achieved if you’re willing to invest in higher-risk loans.
2. Better diversification
Many investors use P2P investments to diversify their overall portfolio. They can then diversify further within P2P, spreading money across multiple borrowers. This reduces risk while maintaining returns.
3. Low volatility
P2P investments don’t sit on the stock exchange, so the returns aren’t greatly affected by fluctuations in the market, therefore returns are considered very stable.
4. An alternative to banks
P2P investing is not a substitute for holding cash in the bank, but it is an alternative which people have been using to generate better returns on their savings.
5. Support businesses and people
P2P lending allows you to invest in businesses and people (consumers). Whether lending to someone who is funding a wedding or a business expanding, your investment supports societies across the UK.
6. Greater control
You decide which platforms to lend across and, in many cases, you can even select the individual loans you want to invest in. This depends on the platform.
Other benefits include the Innovative Finance ISA which shelters returns from tax, the ability to draw an income or grow capital over the long-term, transparency over loan book (depends if the platform offers this), ease of use and so on.
P2P lending is not a savings product, it is an investment which is not covered by the Financial Services Compensation Scheme (FSCS).
7. Passive income
Developing a passive income stream is not so difficult if you begin investing in P2P loans. The effect of easily compounding interest (that’s when both interest and capital are reinvested) makes P2P loans a great investment choice to dramatically increase returns over time. There are no transactional fees to fund new loans, so you earn on everything you invest.
8. Smaller risks
Any investment offers some risk, especially those with higher returns, but because P2P lending is not as volatile as the stock market, there tend to be fewer risks.
You’re also able to see credit rating for the borrowers you’d be lending to, and you can choose which loans to invest in based on those credit ratings, thus additionally minimizing your risks.
In addition to these security measures many P2P providers are zealously looking for ways how to improve the safety measures on their platforms, and there are quite a few capital protection instruments in place already.
Companies like Fast Invest offer protections such as Default and Buyback Guarantees allowing investors to offset late payments and withdraw their funds.
9. Low entry costs
The two biggest companies, Prosper and Lending Club only require a minimum investment of $25, and you are required to invest a minimum of $25 into each loan you want in your investment portfolio.
This low requirement makes it easier for the average American to invest.
10. Industry maturation
The Peer-to-Peer Finance Association (P2PFA) released new data, covering the period between July and September 2017, that confirms “continued steady growth in levels of new lending and in the number of borrowers facilitating loans through peer-to-peer lending platforms.”
P2P can be added to your list of wealth building strategies
Join a lending club today
According to Investopedia, if you don’t start saving until 45, you will need to save three times as much as if you start at 25.
Many adults don’t begin investing in their 20s due to limited funds and expertise, but Peer-to-Peer lending is an excellent option and alternative to traditional investing.
As with any investment, P2P does provide some risk, but as we have outlined, it also provides great opportunities for return.
Joining a lending club may prove to be fruitful for investors of all ages and levels of expertise.