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What is peer to peer (p2p) lending?
P2p lending is a borrow-lend transaction between two parties. The p2p transaction can take place between either a business or an individual.
The lenders or investors provide money to the borrower, who should pay back the loan and interest according to an agreement.
Today there are many p2p lending platforms which manage these agreements.
How does p2p lending work?
Peer to peer lending works by first borrowers applying for a loan with an online lending platform. Then the online platform verifies the borrower and the loan. The platform would check the borrower’s credit history, outstanding debts, income sources.
Once approved, the loan is published to the p2p platform’s website. Then investor lenders can review and then invest in the published loan. In most cases, they can either do this manually or automatically.
Once the loan is fulfilled, the lender will receive the funds.
The investor is then entitled to earn interest on this loan. If the borrower fails to pay, the p2p lending platform will then pursue the borrower in court to pay back the capital and interest.
What types of loans do borrowers ask for in p2p loans?
There are several loan types offered in p2p. The most crucial distinction is between secured vs unsecured loans.
Unsecured loans give the investor no protection if the borrower defaults. In this case, the lender may lose all the capital and interest.
Secured loans come in 2 types. The first type of security is offered by a buyback guarantee. The second type of security is provided by assets the borrower provides.
Borrowers can seek loans for cars, houses, home improvement, debt consolidation, business expansion, invoice financing or many other reasons.
How can p2p lending generate passive income?
A loan is equivalent to renting out of capital.
When you rent a car, you get a car and pay a fee in return. At the end of the rental period, you have to give the car back and pay the fees.
Renting out money is the same. A borrower gets capital and in exchange needs to pay the interest and the capital back.
You get passive income when capital and interest payments are paid back to the lender.
Banks usually were the primary lenders. New p2p lending platforms can have fewer overheads than banks and can pass on these efficiencies to the borrowers and lenders.
The passive income generated is dependent on the interest payments, the interest rate and the ability of the borrower to pay back the loan. The rates of interest vary between 5% and 15%.
Is peer-to-peer lending safe?
There are different aspects of security to consider.
- Safety of the loan
- Buyer not paying back
- Protection from platform failure
- Safety of liquidating.
- Safety of the buyback guarantee
- Trusting the p2p platform
P2p lending is not insured by any central bank or government. The hard truth is that there is no guarantee that money you deposit with a p2p platform can be withdrawn later on.
There have been several write-offs, including Lendy in the UK and the restructuring of Property Moose.
Regulators are new to this, and most European p2p lending platforms are based in Estonia, which might be a good thing or a bad thing. We will only know in 10 years if Estonia has had the right regulations.
Diversity among loans, lenders, loan types, guarantee types allows you to expose yourself to a plethora of risks rather than just one risk.
The assumption is that it is unlikely that all the risks will come to fruition at once, thus being exposed to different risks may protect your p2p portfolio. There are systemic risks which will affect a whole industry, and here diversification outside of p2p is the only answer.
- Watching out for the structure of the loan lenders and how their interests align with yours is essential.
- What is their amount of “skin in the game”?
- How transparent is management about their operation?
- What kind of guarantees do they offer?
- What information do they provide on loans and borrowers?
- Do they provide in-house ratings of the loans listed?
- Do they have a statistics page on their website, with the number of defaults?
- Do they have open-ended loan types (credit line type loans)?
- Do you need to activate the buyback manually or automatically?
- Does the buyback guarantee protect both the capital and interest?
- Are the amounts backing up the buyback guarantee published and transparent?
- Are the contracts between the lenders and the borrowers or between the p2p platforms and the borrowers?
- Is there a third party vetting the loans?
- Is there a third party providing the buyback guarantee?
- Is there a possibility to liquidate the loans
- Is there a secondary market?
Does the Buyback Guarantee make peer to peer investments safe?
Many European p2p platforms offer a buyback guarantee. These p2p platforms promise to buy back a loan whose scheduled payments have not been paid.
This guarantee is as strong, as the entity providing it. If the platform providing the guarantee goes bankrupt, then the guarantee is not there any more.
Which is the Best P2P Lending Platform?
There are a plethora of p2p platforms in Europe
P2p marketplaces (platforms which offer loans from multiple originators)
P2p loan investments
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Real Estate loan investments
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Business loan investments
p2p lending is another passive income asset class which offers high interests; the investment is rather simple to do
Choosing the right p2p provider is critical, and researching the latest market sentiment can help you select the best p2p providers.
Do not invest more than you can afford to lose.
Learn more about p2p investing: