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!

If you enjoyed this post, please consider subscribing to the RSS feed or you are welcome to leave a comment below.