Peer-to-peer (P2P) lending stands out as a really interesting way to make some extra money. It is something that you should know more about since it is a highly underrated money-making option that has fewer risks than most possible investments.
P2P lending appeared because individuals and businesses had problems in getting approved for bank loans, even if they had the ability to easily repay the loans they wanted. People that had money in a savings account were not happy with the interest they got but they did not have the necessary knowledge to put their money in stocks or bonds.
The Basics Of Peer-To-Peer Lending
To put it as simple as possible, through P2P lending you lend money to businesses or individuals. This is done through the use of P2P platforms that act as a middleman.
Since we are talking about a loan, it is normal to receive interest. The rates that you get are much higher than what is possible through a regular savings account.
Because of the fact that banks are removed from the mix, peer-to-peer lending is advantageous for both the lenders and the borrowers. The business/individual that borrows money has to deal with a lower interest rate than what banks charge while the lender gets a higher interest rate than what is possible through the savings account.
How Can You Make Money With P2P Lending?
The steps taken to make money with P2P lending are very simple:
- You sign up to a P2P platform.
- You choose how much money you can lend.
- People/businesses lend money from you.
- When the loan is repaid, you get money with interest, minus a small fee that the P2P platform takes.
Peer-To-Peer Lending Versus Crowdfunding
Numerous people believe that peer-to-peer lending and crowdfunding are exactly the same. This is mainly because both options involve people that come together and offer financial support. However, the two are different. People confuse the two because crowdfunding is too often used as a term that includes all similar financial activities.
Without going too deep into the topic, there are 2 types of crowdfunding:
1. Reward-Based Crowdfunding
Reward-based crowdfunding is what most people know, thanks to websites like Kickstarter. This is where a person/business posts a project and people help with funding. Usually, there are rewards that are given in return. Such an option is not an investment and you do not get money back.
2. Equity Crowdfunding
This is similar to shares investments, which are often referred to as equities. Usually, those that have a startup or a small business have to raise money to grow the business. People can invest in the business and receive a stake in it. If the business fails, you lose the investment. If the business grows, you can get a large return.
In peer-to-peer lending, you do not own a stake in the business. You offer a loan, which is quite different from equity. A specific money amount is repaid over a defined time frame. This includes the initial investment and interest.
Extra Note: You may also see the term “crowdinvesting” used to describe peer-to-peer lending. This is simply because of how popular crowdfunding is at the moment. While numerous people end up investing in a business through P2P lending, the term crowdinvesting is not actually correct.
Is P2P Lending For You?
The answer to this question can only be answered by you. However, there are some really important things to consider:
- You should only invest the money that you do not need right now. For instance, in the event that you do not know if you can make rent next month, it is better not to invest in a P2P platform.
- Do you want higher returns and have no problem with higher risks? In this case, peer-to-peer lending is not necessarily for you since return rates are usually under 8%. In fact, most deals offer around 5%.
- Do you prefer to have others manage your money or do you want to control everything? While with
Top 5 Peer-To-Peer Lending Platforms To Consider
Always choose a highly-reputable P2P lending platform that has a proven track record. Some of the best at the moment are the following:
Upstart was launched by ex-Googlers and is a platform that has a difference. Besides the regular things that are considered, like credit score, are only a part of what is taken into account when considering who to give loans to. Upstart also looks at experience, work history, academic performance, and education, among many others.
The minimum loan amount is $1,000 and the maximum is $50,000. The APR starts at 8.85%. Loans are offered for numerous things, ranging from student loan repaying to boot camp trips. Some borrowers even get aid when they need to support businesses or pay a medical bill. Upstart is nowadays popular among people in their twenties and thirties, without a really long credit history since this makes it difficult to get a loan from a bank.
Funding Circle is different because it is specialized in loans issued to small businesses operating in the US and the UK. What is interesting is that the co-founders from the US actually started the platform after being rejected for a business loan for the 96th time. The success was really fast, leading to billions of dollars offered to businesses from all around the world.
Nowadays, there are many investors that use Funding Circle. This includes even banks, retail investors and the UK government, besides individuals. The loans offered by Funding Circle start from $25,000 and can go as high as $500,000. The maximum loan tenure is 5 years. Loans are offered for various business purposes like hiring extra staff, launching campaigns and buying equipment.
CircleBack Lending gives access to different loan types. The personal loans available start at $1,000 and payday loans start at just $100. Current APR can go as high as 36%, with the rate being determined based on loan amount, credit score, credit history, credit usage, tenure and place of residence.
Personal loans are offered for different purposes, like debt consolidation, credit card refinancing, medical expenses, home improvement loans, motorcycle loans, boat loans, and even vacation loans. Small businesses can use CircleBack Lending to offer personal loans straight to individuals instead of businesses.
Peerform appeared in 2010 thanks to the work of Wall Street executives. It uses 3-year loans between $4,000 and $25,000. The APR can be as high as 30% and is decided based on a unique calculation system called Peerform Loan Analyzer. This system calculates how worthy of a loan a borrower is. Loans offered cover home improvement, moving, medical expenses, installation loans, debt consolidation, wedding loans, and even car financing.
Prosper Marketplace instantly stands out because it was the first P2P lending site launched in the US. Tremendous growth appeared since its inception. Right now, the platform offered $15 billion in loans and helped over 930.000 people. Various different loan options are available, ranging from home improvement loans to engagement ring financing.
The minimum loan amount is $2,000 and the maximum is $40,000. Repayment happens in up to 5 years and rates can go as high as 36%.
A particular advantage for lenders you should be aware of is that you can start investing with an amount that is as little as $25, which is great for first-time investors.
P2P Investment Tips
If you want to make money with peer-to-peer investments, it is important to conduct a really good research and to take it slow. At the end of the day, this is an investment so you have to be careful. In order to increase the possibility of being successful, here are some simple tips to help you make money with P2P investments.
1. Start Investing As Soon As Possible
Because of the fact that you use money that you do not need at the moment, it is time to start making your first investment. The market is more solid than ever and there are more and more P2P lending marketplaces being launched every single year. Billions of dollars are being made in total right now. The sooner you start to invest, the sooner you can earn from the surplus funds you have.
2. Build A Portfolio
If there is just one thing to know about investments, it is that you need to diversify your investments. This is exactly what you should do as time passes. Invest smaller amounts across many borrowers. You can thus get the leverage needed to absorb the shocks that could come from a borrower defaulting.
As the investment is diversified, you get to deal with borrowers that have different requirements, credit scores, profiles and even pay back abilities. This is important because it helps you to get experience. In time, you end up quickly figuring out what P2P opportunities are very good.
3. Remain Invested
P2P investments should always be seen as a long-term venture. Because of this, it is important to keep the funds invested. Do not keep funds idle. When money is idle, revenue is not generated. There are countless asset-classes that you can choose from. It would be a shame not to take advantage of this.
When you invest, try to create a really long-term investment plan, one that covers at least 2 years. This is the very best way to profit from P2P lending.
A huge advantage of P2P lending is that you get money really fast. Payments start to come in from the following month after you put the money in. This is important since it allows you to roll profits. Making re-investments drastically increases your earning potential.
Decide on how much of the returns you reinvest. This is based on your personal wishes and desires. However, according to professionals, if you reinvest you can expect to make around 10% more every single year with P2P lending.
5. Take Advantage Of Marketplace Tools
Peer-to-peer investing platforms give you access to different tools, reports, and data analytics. These are usually added inside the dashboard and help track portfolio performance. Use these to see exactly what is happening with the money that you invest.
The Risks Of Peer-To-Peer Lending
Since P2P lending is still investing, you need to remember the first rule of making an investment:
“Only use money that you do not need and you can afford to lose!”
Losing The Money You Invest
When you get higher returns, you are exposed to more risk. P2P is not as save as keeping your money in a bank savings account. The cash that you put in is always at risk. The good news is that you can always minimize this risk when you choose a P2P platform that has a proven success track record.
Since you lend money, the big risk is that the borrower defaults on the repayment. You cannot get protected through legal protection options, like the Financial Services Compensation Scheme in the UK. In the event the P2P platform fails, money is lost.
A Financial Crash
Another risk is that a financial crash would lead to not being able to sell loans on a secondary market as you try to get money out. At the moment, the P2P market is very strong and stability is high. Even so, you need to be prepared for a potential downturn, which means that many borrowers fail at repaying their loans.
Fortunately, peer-to-peer loans have small interest rates. This means that the real problem is always repaying the initial capital. Because of this, the P2P market is very hard to be tested, even if businesses start having problems, like during a recession.
When it comes to liquidity, P2P lending is not great. After you offer a loan, your funds are not accessible. You will not get the money from the principal back until the loan term’s end. This can easily vary between 2 and 5 years.
Because of the low liquidity part of P2P investment, many investors only use a part of their investment portfolio for peer-to-peer loans.
Every single part of the interest you get is taxable. This is different than with bonds and stocks. Simply put, P2P earnings are going to be taxed at the marginal tax rate.
Based on taxable income and where you live, a large part of the P2P profits is eliminated due to taxes. This is why experienced investors actually rarely invest in peer-to-peer deals. However, this is not a disadvantage for beginners because the investments are stable. Even if income is lower than with other opportunities, it is still something to consider since financial knowledge needed to make a profit is lower.
It should also be added that the good P2P platforms actively mitigate risks through the use of different safeguards. This is why it is so important to choose a highly-experienced P2P platform that has a great reputation. Also, if you want to minimize risks, you want to be especially careful with the presence of provision funds. Having them in place helps reduce risks. Not all platforms use provision funds.
To sum up, peer-to-peer lending is an interesting investment opportunity that is really good for beginners. If you have money that you would normally put in a bank savings account, it is better to loan to others on a P2P platform. This is true as long as you can afford to keep the money in the system for a number of years and you have no problems with reinvesting.