In this low-interest rate environment, every investor wants to invest money to get high returns. But traditional investments like bank loans, saving accounts, bonds, stocks and shares. As a result, investors are looking for alternative investments such as peer to peer lending. It is an excellent investment offering high-interest rates along with several other benefits. Due to these benefits and ease, it has been becoming more and more popular among investors since its establishment.
Peer to peer lending is a way that removes traditional financial institutions or banks from the borrowing and lending process and makes this process easier than ever. All the processes take place through online platforms known as p2p platforms. These platforms match lenders with the potential borrowers and take care of all the processes, from setting interest rates to getting repayment. As an investor, you can invest in different loans such as personal loans, p2p bridging loans, and business, get high-interest rates in return, and make it a source of regular income.
On the other hand, borrowers do not need to wait for weeks or months for approval or complete lengthy paperwork. They can get quick access to funds through p2p loans at a lower interest rate than bank loans. If you are thinking of investing money in p2p lending, you should do research and understand all the essential things to invest in a better way. Here in this article, we are describing five critical things that you need to know about p2p investment.
How Do P2p Platforms work?
Since all the processes take place through p2p platforms, it is necessary to understand how these platforms work and what they offer. These platforms work on a mechanism that connects individuals looking to borrow money to those who are willing to invest their money in p2p loans. They act as a marketplace and connect lenders directly to the borrowers. If you want to borrow or lend money, register yourself as an investor or borrower on a p2p platform and pass through a verification process. This verification process also includes risk evaluation, and you also have to pay a registration fee. Once you are registered as an investor, you can reach out to borrowers on the website and vice versa. On some p2p platforms, you have to manually choose borrowers that match your criteria. While other platforms automatically make lending offers to the borrowers that match your lending criteria.
Borrower’s Evaluation Process
The evaluation criteria vary from platform to platform, and most platforms don’t evaluate borrowers only on the basis of credit scores. They have their own set of checks to assess the creditworthiness of borrowers. Usual checks include credit history, income, and employment. Other than that, platforms evaluate borrowers on the basis of finance management, personal habits and social media activities. On the basis of all this information, these platforms assign borrowers different risk categories which describe the creditworthiness of a borrower. This risk grading helps platforms to determine the amount of loan, interest rate and tenure of the loan. Some platforms also allow the borrowers to select a loan amount according to their risk category and pay a predetermined interest rate, or they can also bid on interest rates with prospective lenders.
Are P2p Platforms regulated?
In the beginning, there were no specific regulations for p2p lending. That is why investors and borrowers consider it a risky option. But now, all the p2p platforms in the UK are regulated and authorised by the Financial Conduct Authority (FCA). All the platforms have an FCA licence to operate in the market and provide p2p lending services. These rules make the process safe and easy for both the investors and borrowers. According to FCA rules, platforms have to put investors only in a ring-fenced account so that even if a platform goes out of business, investors can get their money back. Usually, the loan terms can not exceed more than 36 months. If you want to invest in peer to peer loans, you should always make sure that the platform you choose is FCA authorised so that you can have peace of mind that your money is in the safe hands.
How Much Risk Is For Lenders?
Peer to peer platforms offer loans to individuals and businesses. They also provide loan facilities to individuals who find it challenging to secure a loan from anywhere else due to low credit scores. Borrowers with low credit scores have more chances of default. The risks that you can have in p2p investment as a lender depend significantly on the risk assessment capabilities of the platform you choose. Other than that, you should keep in mind that most of the p2p loans are unsecured, which means you have no collateral from the borrower to recover your money in case of default. The most significant risk in p2p lending is the risk of default when a borrower fails to repay the loan on time. The platforms do not assure full repayment of the loan amount in case of default. However, the platform can assist you in the recovery of loans and filing a legal notice for a positive outcome.
A p2p platform should display all the details of the borrowers, including loan amount, personal identity and credit score, so that lenders can choose easily according to their risk appetite. In addition, one essential thing you should keep in mind is that there is no protection by the government or Financial Services Compensation Scheme (FSCS). Some platforms offer contingency funds to cover lenders in case of borrower defaults. But if multiple borrowers default at the same time, there is no advantage of this contingency fund.
What Can Leaders Do To Reduce Risks?
You should never jump into p2p investment after seeing high-interest rates. Like all other investments, p2p investment comes with risks that you should consider before investing money. You should take the necessary measures to mitigate risks. When choosing borrowers read their risk profiles carefully. Moreover, do not rely only on the platform’s risk assessment and do assess borrowers yourself before granting a loan. Never limit your exposure to a single borrower; you have an opportunity to invest in multiple loans, so create a diversified portfolio. When you have a diversified portfolio, the impact of default is less compared to when you invest all your money in a single loan.
When creating a p2p loan portfolio, add borrowers with varying risk profiles and invest in different types of loans. For example, we suggest you invest in secured loans such as p2p bridging loans so that you can sell the collateral to get your money back.
Peer to peer lending provides an opportunity for investors in this low-interest-rate environment to earn high-interest rates without taking much risk. You can invest in various loans and create a diversified portfolio. Before investing in p2p loans, set your investment goals, understand the process and find whether this investment meets your goals or not. Once deciding to invest in p2p lending, choose an FCA authorised platform and start from a small amount and gradually increase it. You can make p2p lending a source of passive income when you take all the necessary measures to mitigate risks.