In the past decade, many forms of peer to peer investing have developed in countries around the world. Among these various forms of investing, peer to peer loans are the most common. This industry has attracted hundreds of thousands of investors and billions of dollars, making it one of the fastest growing investment options. Read on to find out more about the pros and cons of this investment opportunity, as well as how to develop a good lending club strategy.
There are companies that provide the services required to match up lenders and borrowers. There are called peer to peer lending platforms, and the two largest in the United States are Lending Club and Prosper. The platforms operate websites where people can apply for loans or invest their money in loans to others. Thus, the platforms take the place of traditional lending institutions like banks.
How it Works
Peer to peer lending is a method of providing personal loans to individuals for any purpose. These loans are not collateralized, meaning there is no property (such as a home or car) that will be taken if the borrower does not pay back the loan. Therefore, these loans are relatively risky.
From the borrower’s perspective, these loans are similar to those offered by banks. The application process is similar, although it can only be conducted online and not in an office or bank. Loan applications are evaluated by the platform using the same underwriting standards and practices employed by other lenders.
Investors can pick the loans that they want to invest in. They are provided with information from the loan applications such as income, credit score, credit history, employment, etc. Using these criteria, investors evaluate loans and select the ones that they think will be paid back.
Risks and Returns
As noted, there is some risk associated with these loans because they do not have collateral backing them up. In addition, some of the borrowers have less than stellar credit histories. Loan interest range from 6% to 28% so obviously the higher interest loans have a considerable amount of risk. Investors can choose to stick with the lower risk and lower return loans, or venture into the higher risk loans.
Surprisingly, historical returns for lower risk loans have been as good as the higher risk loans, with each averaging about 5% over time across all loans in each grade. This means that taking on more risk does not necessarily yield a higher return. Therefore, many smart investors only accept the lower yield loans.
How to Succeed
Investors must develop their own Prosper or Lending Club strategy based on their study of the available data and investing goals. This is the most challenging part of peer to peer lending investing. Many investors enjoy the challenge or learning and this industry and picking winners. Investors can set up automated investing, wherein the platform buys loans based on criteria set by the investor. Using this feature, peer to peer lending investing can provide passive income. The account will run on autopilot because as cash comes in from payments it is quickly reinvested in new loans. This also keeps the cash fully invested which ensures the investors does not have a lot of cash that is not earning income. These simple tricks will help ensure success and high returns over the long haul.