Wednesday, October 16, 2019

Peer-To-Peer Lending: A Good Investment

A good investment
Peer-to-Peer Lending is a fairly new industry.  For both the borrower and the investor, it is a real bargain. 
In college I developed what you might call a credit card situation. 

Appalled at the interest rate I was paying, I visited my bank to see if I could refinance to something more reasonable. 

Nope, no personal loans at good old B of A.  I was surprised at just how limited their offerings were: to my recollection only car loans and mortgages were available. 

So I suffered it out and repaid the debt at the exorbitant rate credit card companies get away with.   

Wanna Tie the Knot?  Money Won't Stop You Now

This was the days before peer-to-peer lending, but had it been around, I could have found recourse in them.  Peer-to-peer (P2P) lending companies provide loans for a variety of purposes, including vacations, start-ups, medical expenses, and even engagement rings!   

Now I'm looking into P2P lending as an investor, and like what I see there as well.  P2P lending creates a win-win scenario where both the lender and borrower receive a better interest rate than at a bank. 

If you're new to investing and would like to get your toes wet, P2P lending is an easy way to invest and reap great returns. 

How Does P2P Lending Work?

Money in your savings account may look like it's sitting there, patiently waiting for you to draw it out.  In fact, it doesn't sit there at all. 

A bank uses your savings to dispense loans.  These loans are repaid with hefty interest—a profit the bank keeps for itself. 

Wouldn't it be nice to get some of this profit into your pocket instead?  P2P lending makes this possible. 

With peer-to-peer lending, the borrower applies for a loan through a P2P lending company.  An investor chooses to provide the loan at an agreed-upon interest rate and term.  The borrower pays the company an origination fee, and the investor dispenses the loan. The borrower repays the loan with interest over its term (generally three or five years).  The company keeps some interest (about 1%), while the investor receives the remaining interest and the principle. 

The overhead of a P2P lending company is less than a bank, so they provide better interest rates for the borrower and the lender.  It is also less regulated, and so many different kinds of loans are approved.  However, a P2P lending company is not FDIC insured.  (The FDIC, or Federal Deposit Insurance Corporation, will replenish your money if a bank fails.)  This means the investor stands to lose his or her money if a borrower defaults on a loan. 

Should P2P Lenders Be Experienced Investors? 

Peer-to-peer lending is an excellent place for beginning investors to start.  The concept is easy to understand, and you can start with as little as $25 with Prosper Marketplace

The websites for the leading P2P lending companies are simple and intuitive, clearly indicating the historical returns for different grades of loans.  Companies also have call centers to answer questions and guide new investors through the process. 

What Kind of Return Will I Receive? 

Prosper Marketplace and Lending Club have historical returns between 5 and 9%.  This doesn't guarantee your return, but gives you an idea of what you can expect.  For comparison, a CD at a bank currently provides a return of about 2%

The return will vary depending on the term of the loan and its grade (a riskier D-grade loan has a higher return than an A-grade). 

If you lent $1,000, a 5-9% return means you'd receive between $50-$90 a year in interest, or $250-$450 after five years, presuming no loans defaulted.  Reinvesting the payments (comprised of principle and interest) as you receive them results in a much higher return. 

Before investing in P2P, be sure to have an emergency fund set aside.  Payments on your loan are available as they're made, but if you want the entire loan back before its term, you pay a fee on the unpaid principle. 

How Do I Pick a P2P Lending Company? 

Although P2P lending started about fifteen years ago, it's a booming industry with dozens of large companies.  When choosing a company to invest in, consider its historical returns, loan terms, and the minimum investment amount.  And you can pick more than one--the minimum investment at many companies is quite small ($25-$1,000). 

With 45% of the market, Lending Club (LC) dominates the P2P lending industry.  The minimum investment is $1,000 for a regular account, and $5,500 for a retirement account.  Loan terms are either three or five years.  Historical returns range from 5-8%.  Investors select loans manually or allow LC to choose them automatically. 

The minimum investment at Prosper Marketplace is a paltry $25, making it the ideal company for getting your toes wet.  Loan terms are also three and five years.  At 6-9%, Prosper boasts of higher historical returns than Lending Club, making it possibly the better investment. 

A Real Bargain

As you can see, P2P lending is wealth creation at your fingertips.  Feeling enthused?  Visit a P2P lending company website to learn more.  Your future self will thank you.

This post is excerpted from a white paper I wrote on P2P lending, which is available to read if you'd like to learn more. 

5 comments

  1. Wow good to know! I had not heard of this.

    Allie of
    www.allienyc.com

    ReplyDelete
  2. I never heard about peer to peer lending before. This is an interesting concept. I like the idea of getting a good interest compared to the bigger banking companies. Though, the risk is that if the company flops, you don't get your money back. That's a chance people will need to take. I like that there are different options for different returns. Thanks for sharing these details!

    Nancy ♥ exquisitely.me

    ReplyDelete
    Replies
    1. Yes, there is certainly a risk to investing in P2P, Nancy. In order to get a return higher than the pathetically low risk-free rate, however, you need to assume risk. Investors recommend diversifying, and in the case of P2P, only putting about 10-20% of your portfolio into P2P, and spreading that money across 2-3 P2P companies.
      Thanks for reading!

      Delete
  3. I've actually dabbled in P2P lending back in 2016 and finally paid it off a month ago - the interest rate was way too high for my liking but it helped me out when I needed it the most!

    cabin twenty-four

    ReplyDelete
    Replies
    1. Interesting to hear your experience as a borrower, Eena. Good to have some money available when we need it--but yes, high interest rates suck :(

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