What is P2P Lending?
To decide whether it’s a good investment option you have to understand what it is and how banks lend money out. If you own a bank account then you are already lending money out to people. You store your money in the bank, and the bank lends that out and you earn interest on it. The bank uses your money and assumes the risk of the loan.
With P2P lending it get rid of the bank which was the middle man and there are a few advantages and disadvantages to this.
Pros and Cons.
When you get rid of the bank and lend money out using a P2P network like Ratesetter or Lending Club, you get a higher rate of interest on the repayment of the loans. When you have your money in the bank you might earn 2-3% interest but with P2P you can get a higher interest rate at roughly 6-8 percent and depending on your level of risk it can go higher than 10%.
A quick one for borrowing as well. Because of the nature of P2P, it cuts out a lot of the normal bureaucracy that happens in the bank which means it cuts costs. Generally, because there is less bureaucracy involved, they can offer a lower competitive interest rate compared to the banks meaning if it was a choice between the bank or P2P, overall P2P is going to win out on the interest rates.
It is a very cheap investment to get started on with Ratesetter having a begging investment of only $10 and other brands with minimum investments around the same price.
This is where I would have to state that I personally don’t recommend investing in P2P Lending platforms. I have $100 in Ratesetter at the moment and when the loan comes to maturity I’ll be taking that $100.27 out of the account. That leads me to my first con.
Liquidity, or lack thereof. When you invest your money in P2P lending you don’t have access to that money and interest until the loan has been repaid (Understandably). The lack of liquidity is the biggest reason why I’ll be divesting when my loan has been repaid. Most lending platforms offer 3-5 year loan terms which means when you invest in a loan, you will slowly be paid back over the 3-5 years your principal plus interest. You can’t sell your loan like a share so if you invest $1000 it could be 3 years before you see that $1000 come back with $180 interest. This ties into my next point.
There is a possibility for you to lose your entire principal if a borrower defaults on their loan. Ratesetter offers a provision fund to protect it’s lenders but it is still not a guarantee that you will not lose your entire investment which Ratesetter themselves stress in their own information document about their provision fund. With the lack of liquidity you need to take into account the economy. It’s possible that there will be another recession which could result in millions of people losing their jobs, some of those people being your borrowers. In the event that happens I don’t see it as unlikely that the Ratesetter provision fund could run out. Because you can’t sell your investment, you might just lose the whole lot.
Tying back in with losing your entire principal, when you use P2P lending, you assume the risk of investment. Usually the bank assumes the risk and if the bank loses money that it invested from your account, you don’t wear the cost of that, they do. With P2P, you assume the risk hence the realistic likely hood to lose your capital. Also, if these lending companies go bankrupt, it’s likely that you will lose your principal there as well because the first people to get paid are the creditors of the company and technically you aren’t a creditor of the company, more like a user of their platform, so if they go bankrupt, you won’t be at the top of the list.
So what’s the verdict?
That con list is a little bigger than the pro list. As I previously stated, I have money invested within Ratesetter and I’ll be pulling that money out when the loan matures. My personal opinion on the matter, is that there are just better investment options out there that offer the same if not a better ROI compared to P2P lending as well as those options being easy to liquidate in the event that you wish to either access the money or move the money to a new investment. The lack of liquidity and not very competitive ROI means that it’s a no from me.
However if you want to borrow from these platforms, they do offer a very competitive interest rate compared to the banks so you can save your self thousands buy using these P2P platforms for borrowing as opposed to lending.