Is Peer To Peer Lending Worth My Investment? Comments26 Comments

Hey everyone, thanks for joining me today for this week’s Monday Money. I’m Joshua Rodriguez, the author and editor behind this column. Today I’m going to talk about an investment opportunity that seems to be trending these days, peer to peer lending. Although, most peer to peer lending websites boast big returns, many investors are scared of the concept of loaning money to consumers who could possibly take the money and run with little recourse. So, is this a good idea? Let’s dig a bit deeper into the concept to find out.

What Is Peer To Peer Lending

Peer to peer lending is a fairly new form of investment. Although, it’s been around for about a decade, the process has really grown in popularity in just the last few years. With peer to peer lending, the investor gives a loan to a consumer in need. Of course, the consumer is required to pay back that loan with interest. As the payments come in, the investor makes money from the interest that is being charged to the consumer.

What Happens When People Don’t Pay Loans Back

Unfortunately, in any peer to peer lending situation, you run the chance of dealing with a default, the borrower’s inability to pay off the loan. In these situations, the lender, or investor is out of luck. Although there are tons of peer to peer lending platforms like Prosper out there, I have yet to find one that guarantees returned funds. The simple fact is, the nature of lending is that some borrowers will not pay their debts, and some borrowers will.

How To Safeguard Yourself Against Defaults

No matter what you do, if you plan on investing in peer to peer lending for a while, chances are, you’ll run across a default or two. However, there are ways to lessen the painful blow of these occurrences. First off, as with any investment, you will want to diversify quite a bit. With peer to peer lending, you are able to fund loans with as little as $25 dollars. Instead of putting $2,500 into one loan, consider funding 100 $25 loans. If someone wasn’t willing to pay back the $2,500 that they borrowed, you’d be in a position of huge losses. However, if someone wasn’t willing to pay back the $25 that they borrowed, you’d have plenty other loans and the interest attached to those loans to make up for the loss.

Also, you want to be smart about choosing the loans you plan to fund. One of the reasons big banks got so big is because they know how and when to say no. In peer to peer lending platforms, you are able to see a lot about the borrower. Most will show you the borrower’s credit score, outstanding loans, income level, etc. If you see that the borrower has a low credit score or high debt to income ratio, don’t fund that loan!

My Overall Thoughts Of Peer To Peer Lending

The bottom line is that peer to peer lending is a bit risky. It requires you to be able to gauge the ability of a borrower to pay back the loan. However, if you make sure that you only fund loans that have a high probability of paying back their debts, chances are you will be able to make more money through peer to peer lending than investing in stocks and bonds.

Reader Question

Have you ever tried peer to peer lending? If so, what was your experience? If not, would you consider an option like this? Please answer in the comments below!

Author Bio: Check out Josh Rodriguez at his blog cnafinance.com where he writes about a wide variety of finance topics.

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By : Josh Rodriguez | 11 Nov 2013
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26 thoughts on “Is Peer To Peer Lending Worth My Investment?

  1. Dee @ Color Me Frugal

    We’ve spent a lot of time thinking about whether we should invest in peer-to-peer lending or not. We are not so much concerned about the risk (although we know it’s certainly there) as we are concerned about the tax ramifications. When we checked with our accountant we were told that any money we would make from peer-to-peer lending would be taxed at our ordinary income tax rate. That’s what has us stuck on whether to invest in it or not; we kind of think we might be better off investing our money in something that might have more of a tax advantage for us. Still thinking about it…

    Reply
    1. Joshua Rodriguez

      Hey Dee, thanks for your comment. I’ve heard the same thing about peer to peer lending. As far as taxes go, it really depends on what your goals are. There are definitely ways to invest and save on taxes at the same time, but I’m not the guy you would want to talk to about that. Getting in touch with a local financial advisor is a good idea. Of course, they make no money on Peer to Peer lending, so, they may sway you away from it. None the less, there are tax issues with most investments and I think the best way to start would be to learn about different investment types and the taxes that come along with the earnings.

      Reply
    1. Joshua Rodriguez

      Hey Lance, thanks for your comment! It does take a bit of time to find the loans you want to fund, however, your money should never sit in idle. The truth is, if you go with a larger platform like Prosper, you’ll never be able to fund all the loans available, even if you were only looking at low risk. There’s just so demand that letting your money sit idle shouldn’t happen.

      Reply
  2. getrichwithme

    I’m not the biggest fan of peer to peer lending.
    You’re putting your capital at risk as p2p lending companies are not regulated.
    However, with savings rates so low – I can see the attraction to get a better return

    Reply
    1. Joshua Rodriguez

      You’re very correct. Peer to Peer lending is unregulated. However, it looks like that’s about to change very quickly. None the less, even without regulation, you’ll find that using larger, reputable companies will keep your money safe! Thanks for your comment getrichwithme!

      Reply
  3. Debt Blag

    In theory, it should work great, right? The difference between the interest rates I see on my student loans and the minuscule rates everyone gets on their savings has to go somewhere.

    I guess the one shortcoming is that, besides the nice buildings and high salaries, banks also put together the complicated, always improving models that tell them how much to trust different borrowers.

    That said, I’m currently a net borrower. Would be interesting to see the perspective from the other side….

    Reply
  4. writing2reality

    I have been investing with Lending Club for well over four years now, and just this past spring started an account with Prosper. I have only had good experiences so far, but like others, have experienced the loan crunch of late with Lending Club. The need to log in regularly at specific times is fine for an active investor like myself, but a challenge for those who would prefer a more passive means of investing.

    As for some of the concerns with defaults, it is simply a matter of diversification. For example, my Lending Club accounts combine for almost 700 notes, and I have never lost money with my investment. In fact since I started investing with Lending Club, my actual returns have been in excess of 10%.

    For anyone considering peer-to-peer lending as a potential investment, I highly recommend doing your due diligence and researching what you are looking to get out of this type of investment.

    Reply
    1. Hrant

      since I am writing2reality, I do want to reiterate the same feelings, as am making a good return, over 4 years investing, thousands of notes, yet am feeling that if a more automated, or another vehicle to invest thru was available, would definitely consider joining to minimize time spent.
      And yes, please make sure you understand you may be investing for the long term. This is definitely NOT a get rich quick scheme:), yet a long term 3-5 year returns plan, rolling forward plan.

      Reply
  5. Kali @ CommonSenseMillennial

    I’ve always thought peer-to-peer lending was a really interesting concept, but I’ve never tried it myself (either borrowing or lending). I’d be interested in trying it as a lender.. but I’d be really, really afraid I wouldn’t get my money back. I know with any investment comes risk, but I’m unsure that I could handle this kind of risk. It’s definitely something to think more about!

    Reply
    1. writing2reality

      I’d encourage you to look into it Kali! You might be pleasantly surprised to see that over the long-term there are quite a lot of resources out there that support positive returns. For example, every investor to have invested in 800 or more loans with Lending Club has never lost money.

      Reply
  6. Brian @ Luke1428

    I’m not sure I would call P2P lending an investment…feels a lot more like a gamble. People have difficulty enough gauging the ability of people they know (like friends or family members) to pay back a loan. How can I gauge the ability of someone I don’t know to pay back a loan? I don’t see the attraction here as an investment. Maybe for altruistic reasons, just to help other people out.

    Reply
    1. writing2reality

      Under that pretense, why would banks ever lend anyone any money? Are banks in the business of gambling or generating profits. I suspect the later. When looking at peer-to-peer lending, it is imperative that you look at things from a credit standpoint, much like a bank would. Like the institutional investors who are also investing, I don’t invest in Lending Club or Prosper for any reason but money making. I’d recommend checking it out.

      Reply
  7. Kim@Eyesonthedollar

    I haven’t tried P2P lending. I think it might be an interesting part of a well balanced portfolio, but I wouldn’t make it your main investment. I think some risk is fine as long as it’s only a part and not the whole pie.

    Reply
  8. Micro

    I’ve had an account with Lending Club for about 6 months or so. So I’m still fairly new to the peer-to-peer lending market. I’ve been suprised at the amount of resources available to help investors build their selection criteria. Being able to see past results on 4 years worth of data helps ease my nerves a little bit. Now, past performance is no indication of the future but it’s all we have to go on.

    Reply
  9. Hayley @ A Disease Called Debt

    Peer to peer lending is something that I haven’t considered before but I might well look into this further in the future. I like your suggestion about spreading the risk by offering many loans but of a smaller value in case of defaults. I’d definitely be looking for as small a risk as possible!

    Reply
  10. Anton Ivanov

    I’ve tried P2P lending myself and you’re absolutely right – it is very important to understand the associated risks before jumping in.

    Great post and I’ve just featured it in my latest roundup!

    Reply
  11. Will Smith

    My problem is most peer to peer lending is people lending to companies, I need 7k to fix my life (lawyer/court fees from a pot charge 12yrs ago, college difference/remaining balance for transfer credits, left over medical bills in collection from frontal lobotomy) I have already paid out the ass on all this to get it down to 7k but getting a job/getting a loan/finishing my degree is all a catch 22 I have experience certifications and education in my career that would pay me over 100k annual but cant get a job due to court crap, cant get a loan due to medical crap, cant finish my degree in programming due to no grants because I made to much money in 2012 (was working). Ive never had a loan outside of school (which I’m very careful with) never had a CC for over $700 (which are all in good standing), never filed bankruptcy or any crap like that but I have a credit score of 600 so no bank will lend, a warrant out for my arrest, so no one will hire, and normally make to much money so no one will grant. I am screwed everywhere I look!

    Reply
  12. Jack @ Enwealthen

    I have two concerns with peer to peer lending:

    - the lockup
    - institutional failure

    Since it’s a loan, P2P investments can take several years to recover, so if you need your money in a hurry for some reason, you’re not going to be able to access it. It’s more a long term CD than a bank account or even a stock market investment.

    Prosper and Lending Club have not been in business long. Prosper in particular has had some stability concerns in the past. What happens when one of these P2P companies goes under? AFAIK, neither are banks and are not FDIC insured, so if they go bankrupt due to financial shenanigans on their part, or anyone else’s, I suspect the individual account holder will be last in line behind all other creditors and likely get back pennies on the dollar.

    I consider peer to peer lending a sideline, but I wouldn’t invest a significant amount of my investment funds in it.

    Reply

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