Is P2P Lending a Safe Investment Platform?
With bond yields at all-time lows, you may be considering alternative fixed income investments to increase your returns. One of your options is peer-to-peer lending, which involves investing in different types of loans.
The most common P2P loans are unsecured personal loans, but you can also help fund mortgages, car loans, business loans, and more.
P2P loans can provide excellent returns of up to 12% or more. But since you’re lending to consumers who may default on their loans, there are risks involved with this type of investing.
Here’s an overview of the risks and benefits of P2P loans to help you decide if they’re the right choice for your portfolio.
Is P2P Lending Safe?
As with any investment, there are risks associated with P2P loans. The borrowers you lend money to may not be able to pay it back, which could cause you to lose some or all of your investment.
Because P2P lending has only existed since 2005, there isn’t any data on how these investments perform during recessions. When there’s an economic downturn, more consumers may default on their loans, which is something to keep in mind.
Luckily you can spread out your risk by investing small amounts of money in a wide variety of loans. Many platforms allow you to invest as little as $25 in each loan, which allows you to diversify your portfolio. If a borrower defaults, you’ll lose less money as a partial investor than you would if you had funded the entire loan.
Certain types of loans also have different levels of risk than others. Unsecured personal loans aren’t backed by collateral, so there are no assets to sell if the borrower defaults. This means that you may lose more of your money with unsecured loans than secured ones.
However, most originators that facilitate P2P loans only work with qualified borrowers who have credit scores above 600. You won’t be investing in subprime loans, which lowers your chances of losing money.
If you want to be even more conservative, you can stick to loans that have high credit grades. This means that the borrower has a high credit score and low debt-to-income ratio, so they’re more likely to make their payments on time.
Keep in mind that loans with high credit grades usually yield lower returns because they’re safer. So if you have more tolerance for risk, you may want to choose a mix of higher and lower credit grades to maximize your earnings.
Are There Any Protections for Investors?
Some P2P loans have protections that help reduce your risk as an investor.
The most common one is a buyback guarantee in which the loan originator agrees to buy back part or all of the loan if the borrower defaults. This means that you won’t lose everything you invested if things go wrong.
The only problem with the buyback guarantee is that the loan originator probably won’t be able to honor it if they go out of business. This happened with an originator called Eurocent on Mintos, a popular European P2P lending platform.
Mintos did everything they could to try to recover the money, but their investors likely experienced losses. So even if a P2P loan has protections, you shouldn’t invest more than you’re prepared to lose.
Other Ways to Lower Your Risk
Because P2P loans can be riskier than bonds and other fixed income investments, it’s recommended that you don’t chance your entire nest egg on them. Instead, keep them as a smaller part of your portfolio alongside more traditional securities such as stocks, bonds, and mutual funds.
Another way to lower your chances of losing money is to make sure you’re using a reputable lending platform. Find out how many years the platform has been in business and what kind of protections it offers to investors. Investing through a P2P site with a good track record will help reduce your risk.
To learn more about peer-to-peer lending and find the right site for you, take a look at this list of the best European P2P lending platforms.