Peer to Peer Lending Risks And Ways To Mitigate These Risks
Peer to peer lending is a process that matches borrowers to investors through an online platform. It is beneficial for both the investors and the borrowers. Investors can earn high return rates by investing in peer to peer loans. For borrowers, it is relatively easy to get loans as compared to traditional bank loans. Peer to peer platforms also offer loans to individuals who have poor credit ratings. P2P lending allows people to get loans directly from the authorised persons and cut the middle man. However, like all other investment types, P2p lending also has some risks. You can make better returns if you understand where the risks are and how you can manage them.
Here in this article, we are describing the risks associated with peer to peer lending and some ways to avoid these risks.
P2P lending Risks
P2p lending has three significant risks:
- Risk of borrowers default
- Risk of loan originator going bust
- Risk of platform going bankrupt
Let’s look closer at each risk and find how they can occur and affect you as an investor.
Risk Of Borrowers Default
P2p lending is a debt-based investment in which investors lend money to individuals or businesses. Investors get profit in the form of interest from the loans. It means the major risk in p2p lending is borrowers risk. Borrower risk means when a borrower defaults and can not repay the amount borrowed. In this way, you will be unable to get the potential interest. This risk is more significant because most of the peer to peer loans are unsecured. It might be possible that you may lose all your investment if a loan goes bad in the early term.
The Risk Of Loan Originator Going Bust
There are some platforms that act as loan originators. These entities used to find borrowers and send them to peer to peer platforms. It means that you are not lending money directly to the borrowers but to the loan originator. In the case of repayment, the borrowers pay the debt to the loan originator, who again will pay the lender through the platform. In this model of lending, the originator sells loans to the lender. If the loan originator goes bust, you will not be able to get your money back from the borrowers.
Risk Of Platform Going Bankrupt
Peer to peer platforms make money from the fees they charge from the investors and the borrowers. Sometimes a peer to peer platform goes out of business if it is unable to earn enough money. You may think about how a platform itself goes bankrupt. We all know that peer to peer platforms are responsible for collecting repayments and managing all the investments. It is a lengthy process, and some platforms use a backup loan servicer to pay back the loans to lenders when a platform itself can not do so. When the platform can not repay the amount to the loan servicer, it becomes bankrupt; thus, the credit of all the investors is at risk.
Ways To Mitigate P2P Lending Risks
Just because peer to peer lending is not a risk-free investment, it does not mean you should not invest in this type of lending. There are several ways you can use to minimise these risks and earn profit without any hassle.
Diversification is the key to mitigating the risks. You should put your resources in different asset classes in small amounts to diversify your portfolio. While investing in P2P lending, you should spread your investment across multiple small loans to reduce the risk of borrowers defaulting. In this case, if one loan goes bad, you can still earn profit from the other loans. Many P2P lending platforms now offer auto investment tools that take decisions on your behalf and diversify your investment effectively.
Choose the Right Platform
Many platforms are available in the market offering peer to peer lending UK. Not all these platforms are reliable, and you must shop around and research to check the transparency of a platform. Reputable platforms do not charge any hidden fees from the investors or borrowers and have low default rates. Moreover, you can check online reviews of a platform to check transparency. After complete research, select a platform offering high-interest rates and following best lending practices.
Start From Small Investment
When you are making an investment decision, no matter which type of investment you are going to invest in, never invest all your money. Take time and think about how much you can afford if a loss occurs in investment. The amount you are investing in peer to peer lending should be based on your risk appetite. In the beginning, start with a small investment and gradually increase your capital after understanding the rules of p2p lending. Do not make bad investment decisions by thinking that the more you invest, the more interest you can earn.
Keep On Reinvesting
It is better to keep your finances running instead of holding them inert. Because you can not earn profit from inert cash, if you have a goal to keep your benefits growing, you must keep on reinvesting and do not let your capital sit inactively. You can use the auto-invest option. Once you set up criteria for your credit to invest in, auto-invest will automatically dispense your money into new advances whenever you have enough money in your account. However, some investors do not like to use auto-invest and invest manually every time in p2p loans.
Now that you have information about the risks in peer to peer lending and the measures you can take to reduce these risks. It will be easier for you to manage your p2p investment in a better way. Every investment comes with its rewards and risk, and the same is in peer to peer investment. Therefore, you must understand all the positive-negative sides of P2p lending and then make a decision based on your individual circumstances and risk appetite.