Websites that bypass the banks by matching up lenders with borrowers have been taking off for a while now, some claiming to offer returns of 10%-15%. There are a few big players in the game but new companies seem to be launching almost weekly. So should you be signing up – and is it safe?
How does it work?
Lending platforms like Lending Club and Prosper have quickly become popular P2P lending platforms. These websites simplify the process and do a lot of the work for you, like bookkeeping and transferring the funds. After signing up with the website, borrowers essentially just select a loan amount (up to $35,000 if you’re using Lending Club) and describe where this money is going before posting a listing to the site. Investors, sort through the listings and invest in whatever they think will fetch the biggest returns. Borrowers make monthly payments, which investors receive a portion of.
Because loans are uninsured, default can be especially painful for investors. For some, this risk is worth it, as returns can be substantial. Personally I have invested in Lending Club and my returns have been somewhere around 8% (10% without considering defaults).
How to minimize your risk
P2P lending can be as safe or as risky as you want it to be. For those new to P2P lending, the best advice is to start conservatively and also diversifying your investments. Don’t lend all your money to one borrower. Instead, spread small amounts of money to many borrowers. This will protect you from a devastating default. With Lending Club or Prosper you can opt to fund only a portion of the loan amount that the borrower is requesting. Prosper for example, claims that, since 2009, investors with 100 or more loans in their portfolio have never lost money. So far, only about 8% of my loans have defaulted. Background checks serve as another security blanket: websites like Lending Club perform background checks on borrowers, which eliminate a lot of the mystery associated with lending money to someone you’ve never met before. You’ll know the credit score of whomever you are lending money to, along with other pertinent facts about their financial background.
Is It Worth Investing?
P2P lending will nit be a quick money maker, but it can be a great addition to your investment portfolio if you diversify your investments. I have had money invested in Lending Club for a few years now. Whether you decide to invest or not, you should remember to practice good judgment, just like you would when making any other important financial decisions.