Peer to peer lending is a relatively new way of lending that cuts off traditional financial institutions and banks from this process. It makes the lending and borrowing process easy for both the investors and lenders. In the past, you had to go to high street lenders or banks when you were in need of money and had to wait for weeks or months to get funds. But now, you can go to p2p platforms that match you with the investors directly and grant funds within the shortest possible time. Investors are getting into this alternative investment due to the high-interest rates on p2p loans. Other than high-interest rates, it offers several other benefits to the investors, such as diversification and investing through IFISA to get maximum returns.
P2p Lending Categories
A different peer to peer platform offers different types of loans in which you can invest. But following are some major categories from which you can choose:
Lending to Individuals:
P2p lending was started from personal loans. Individuals can take out money to fulfil personal financial needs, and you can fund these loans. Borrowers will repay the loan plus interest rate in instalments over an agreed time.
Lending to Properties:
In this type of lending, you invest in loans to the property developers and investors. These loans help them to complete development or renovation projects. Once the project is completed and the property is sold or rented out, the borrowers will get the cash and repay the loan amount along with the interest rate.
Lending to Businesses
Peer to peer loans are very useful for startups and small businesses as they can get quick funds to overcome business cash flow problems. You can invest in business loans through p2p platforms.
All the loan categories have their own risks and rewards, so you should keep in mind your investment goals before making a final decision.
P2p Lending Risks
Although peer to peer lending offers numerous benefits to investors, it does not mean it is free of risks. Like all other investments, it comes with some risks that can result in monetary loss. Here we are describing three major risks.
The credit risk is one of the most significant risks in peer to peer lending UK. When your borrowers are not able to repay the loan amount, it is known as credit risk. From all the p2p lending risks, it is the most time evaluating. When one or two loans go bad, you can expect that the interest you earn from good loans will cover the loss. In other cases, you may have additional protection, such as when you invest in secured loans, you have the borrower’s real estate as a security against the loan. When a borrower defaults, you have a right to sell that property and get your money back. In addition, some platforms offer provision funds to cover the defaults.
However, in extreme cases when multiple borrowers default simultaneously, all these protections are of no use, and you can lose all your money. The severity of risk varies from platform to platform.
So you may now think about how you can reduce this risk. First, you can reduce this risk by choosing a platform that focuses on high-quality borrowers and has strict screening processes to reduce the number of defaults. Moreover, look at the track record, number of defaults and other statistics of a platform before selecting a platform. In addition, spread your investment across multiple loans to create a diversified portfolio and keep defaults as minimum as possible.
You can also be a risk when making a p2p lending decision. For example, when you ask yourself the question, ‘is it safe to invest in p2p loans, ‘ negative thoughts usually come to your mind and urge you to take a step back. In such situations, relax and look at facts when making lending decisions. Investment decisions are more about yourself than anything else.
What is happening inside your head is the essential thing in p2p lending. You may become greedy when it’s time to be cautious and may get scared when it’s time to be greedy. It is known as psychological risk. Some investors jump into p2p investment by seeing high-interest rates and investing all their money to get higher returns and lose their money. You get down due to greed, pride and fear. It is always better to start investing after understanding the whole process.
You can reduce these risks by ignoring all the things and setting your investment goals that are easy to follow. For example, you can decide to lend to those with a good credit score or experience property development.
If you invest all your money in a single loan, no matter how strict a peer to peer platform is in evaluating loan applications, you can lose all your money if the borrower defaults. It is known as concentration risk that occurs due to insufficient diversification.
Now let’s see how to mitigate concentration risk in p2p investment.
This type of risk can be minimised by splitting your investment across different types of loans. P2p platforms allow you to choose borrowers and invest in different types of loans, including personal, business and property loans. You should always create a diversified portfolio with a varied mix of borrowers. You must have low, medium and high-risk borrowers in your profile. This way, you can mitigate risks and get the most out of your investment.
Peer to peer lending is an excellent alternative investment offering higher returns than conventional investments and bank savings accounts. That is why it is expanding day by day. However, you should not jump into it by seeing high returns and must keep the above-mentioned risks in your mind. In addition, remember that the higher the interest rate, the higher the risk of default will be. Therefore, you should have a diversified portfolio, including borrowers of different risk profiles. This way, you can keep the risks to a minimum. Moreover, choose a well-reputed and experienced platform that has a transparent track record and borrowing history. All of this can help you to reduce p2p lending risks significantly.