Peer-to-peer lending, also known as P2P lending, is a relatively new form of investment that has gained popularity in recent years. It involves connecting individual investors with borrowers who are seeking loans without the involvement of traditional financial institutions like banks. In this post, we will explore what peer-to-peer lending is all about and how it works.
How Does Peer-to-Peer Lending Work?
In a typical P2P arrangement, borrowers apply for loans through online platforms such as Lending Club or Prosper. These platforms screen the applicants and assign them risk ratings based on their creditworthiness. Investors can then browse the listings of potential borrowers and choose to fund individual loans in increments as small as $25.
Once enough investors have funded a loan request, the borrower receives the funds and begins making regular payments back to the lenders with interest. The P2P platform handles all aspects of loan servicing including payment processing and collections.
What are the Advantages of Peer-to-Peer Lending?
One of the primary advantages of peer-to-peer lending is that it offers higher returns than many other forms of fixed-income investments like bonds or CDs. According to Lending Club’s website, historical returns for investors range from 5% – 8% annually depending on risk level.
Another advantage is that P2P lending allows investors to diversify their portfolios by spreading out their investments across multiple borrowers with varying degrees of risk. This helps reduce overall portfolio volatility while still generating solid returns.
Finally, P2P lending provides an opportunity for individuals to invest directly in people rather than faceless corporations or government entities. Many investors find this aspect rewarding because they can see how their money is being used to help others achieve their goals.
Are There Any Risks Involved With Peer-to-Peer Lending?
As with any investment strategy, there are risks involved with peer-to-peer lending that potential investors should be aware of before getting started.
The primary risk is default risk, which is the possibility that a borrower will fail to repay their loan. While P2P platforms do their best to screen borrowers and assign them appropriate risk ratings, there is always a chance that some loans may go into default.
Another potential risk is liquidity risk. Unlike stocks or bonds, P2P loans are not tradable on public markets, meaning investors may have difficulty selling their investments if they need cash quickly.
Finally, P2P lending is not FDIC insured like traditional bank accounts, so there is no guarantee of protection against loss in the event of platform failure or fraud.
Conclusion
Peer-to-peer lending can be an attractive investment option for those looking for higher returns than traditional fixed-income investments while still maintaining diversification and helping people achieve their financial goals. However, it’s important to understand the risks involved before getting started and carefully consider whether this strategy aligns with your overall investment objectives.