Among the vast area of options available to investors is a unique arrangement called peer to peer lending. Peer to peer investing enables individuals to fund personal loans and receive periodic principal and interest payments until full loan repayment. In the United States, this type of investing started in 2006 and has grown into a multi-billion dollar annual industry.
What You Should Know About Peer to Peer Investing
Many investors with both small and large amounts of money are turning to this option. Some are including peer to peer investing in their Individual Retirement Accounts. But, there are some things that you should know if you are considering this type of investment.
While it can be smart to include a peer to peer investing account in your portfolio, you should be aware of the risks and potential downside. Ultimately, careful research is necessary before making this decision but here are some things to know about peer to peer lending.
Peer to Peer Investing Platforms
The first thing to know about peer to peer investing is that all transactions are managed by an intermediary. These intermediaries work as platforms and include companies like Lending Club in the United States.
The platform handles all aspects of underwriting and administering loans, including:
- qualifying borrowers,
- releasing funds, and
- collecting payments.
The platforms provide information to lenders on all available loans for the lender to select specific loans for investment. In addition, they handle allocating payments to lenders.
How It Works
To start lending club investing, you will simply need to open an account with one of the platforms described above. The minimum amount required to open an account is usually $1,000. Once there are funds in your account, you can immediately begin investing.
The platform will provide extensive information about each loan and borrower, including:
- credit history,
- length of employment, and
- reason for the loan.
Using this information, investors choose the loans they think will be repaid in full. Investors may also use the platform’s automated investing future. The investor simply sets criteria. When peer to peer lending in this way, whenever a loan becomes available that meets the criteria, it will automatically be added to the investor’s portfolio. It is important to note that you only need to invest a minimum of $25 in an individual loan.
Risk and Returns For Peer to Peer Investing
Peer to peer lending and fixed income investments, such as bonds, are actually quite similar. Lending club returns can vary based on:
- the risk preferences of the lender,
- overall performance of loans issued by Lending Club, and
- economic factors.
Historically, 80% of investors have earned between 1.2% and 5.5%, with the medium annual rate of return being 3.6%. Rates of return are actually a little lower for portfolios with lower risk. This means, the borrowers have better credit and the loan interest rates are lower. Smart investors with a good strategy to select loans can do better than the average investor. Investors who are new to peer to peer lending may want to stick with the less risky loans.
Lending Club claims that 98% of peer to peer lending investors with a properly diversified portfolio have made money on their investment. In order to minimize risk, it is essential that investors diversify their portfolios. You can do this by investing small amounts in a large number of loans.
Overall, peer to peer investing seems to carry more risk than other fixed income investments. However, the returns can compensate investors for that risk.
Peer to Peer Investing – The Bottom Line
If you are looking for an investment to help diversify your portfolio and as an alternative to bonds, peer to peer investing may be right for you. However, it is important to fully understand this investment and how to select specific loans. This is not something you want to learn by trial and error, so do your homework before you start.
Have you ever tried peer to peer investing? What were your thoughts? Comment below!
AUTHOR LaTia Longuemire
My name is LaTia Longuemire. I enjoy writing, singing, and cooking in my spare time. My passion is helping others. At this stage in my lifetime, I'm primarily focused on my children. They are everything that keeps my world spinning.