Pros and Cons of Peer-to-Peer Lending Platforms
Peer-to-peer lending is a relatively new way for people to take out and add to their funds that involves both benefits and drawbacks.
Investors should try to assess their highest risk tolerance before determining if peer-to-peer loans would be the right option for them. Below I have compiled some major pros and cons associated with peer-to-peer lending: 1. Diversification.
Diversification
For those seeking solid returns that also allow for diversification, peer-to peer lending allows you to lend money directly (to people) at decent interest rates. Many peer-to-peer lending platforms vet borrowers themselves or make borrower information available to investors for risk-management: don’t expect returns while wilfully ignoring the possibility of defaults and losses. Only ever invest what you can afford to lose, and divide your money out across numerous numerous borrowers so it doesn’t all go to one. Furthermore, by spreading your investments across many loans on a platform, you can mitigate the risk of a default or late repayment by investing across many different loan types and borrower profiles. Potential investors in peer-to-peer lending should also do a short piece of due diligence on the platform itself – look for peer-to-peer lending platforms with clear, published information on the performance of the loans and the borrowers themselves. This will help to ensure your investments are as safe as possible.
Lower Costs
This directly matched lending between borrowers and lenders, means less expensive borrowing and less expensive lending. Some P2P platforms charge fees, which of course reduce the returns for the investor, like loan origination or servicing fees. These might have monthly or annual membership fees too, so check fine print and do not hesitate to compare current fee structures of p2p lending platforms – they must be transparent about that, and include it in their FAQ (frequently asked questions) section. High APR might be offered at p2p lending platforms (in the range of several percentages annually) compared with traditional bank savings accounts or fixed income instruments, so remember to diversify as much as possible and indeed there is no need to invest everything – put just a bit aside to create a pool of investments over a longer period of time. Avoid putting uninsured amounts in one place, as usually diversification is a safe strategy. Never invest money you cannot afford to lose – it is a wise slogan to repeat to yourself when preparing your investments, but better than thinking ‘never’ might be to think ‘rarely’. If you absolutely need to accelerate your retirement savings and use your cheap money when interest rates are low, the idea of investing in loans granted to SMEs might be an interesting option for you. We could even call it an exotic investment – think of rare orchid flowers or even Venus flytraps.
Higher Interest Rates
While most P2P lenders have stricter criteria than the bank, some aim for a broader market than traditional banks (which can lead to higher borrowing costs for the individual, because this inclusivity is compounded by an increased interest rate). By offering unsecured consumer loans, lenders who work through these sites are leaving themselves open to borrowers defaulting on their debt and reducing their investment returns. There are tools to evaluate risk on these sites, but borrowers could still default on their loans and pay back nothing. Investing in these lending platforms will not be covered by the Financial Services Compensation Scheme so, should a platform find itself in financial straits or close down, investors could run the risk of losing their investments. As a result, it makes sense to spread your portfolio among several platforms and to never invest more than you can afford to lose.
Lack of Regulation
P2P lending platforms might be non-banks, but they provide similar credits intermediation services to the banks and other financial institutions, which come under the numerous consumer financial protection acts that directly regulate individual lenders. P2P lenders should offer near-transparency: clear disclosure of borrowers and their details, and specification of how much money the lender will make minus the factoring costs; additionally, a clause specifying the contingencies provided in case the company goes south. P2P loan investors don’t have deposit insurance protection! As investors, you should spread your money over many borrowers, you may want to check out borrowers carefully before lending, and borrowers from such lenders can be riskier than each individual depositor at the typical bank.
Lack of Flexibility
An advantage of peer-to-peer lending platforms is that the application process is usually straightforward and flexible. The borrower is provided with an opportunity to adjust their loan terms based on their own financial ability. However, some peer-to-peer lending platforms might have a relatively inflexible repayment schedule. Lending via peer-to-peer sites carries the risk of being lent to a borrower that might default on a loan. To minimise this risk of loss to lenders, investors should spread their portfolio of lending over a large number of borrowers and evaluate borrower creditworthiness when selecting loans to bid upon. In conclusion, peer-to-peer lending is good for both borrowers and investors. lt only makes sense that Purchasers calculate carefully the benefits versus the detriments of P2P lending before reaching the decision to buy.