Peer to peer lending is a very recent investment product, and due to that it is not known by most people.
I’m sure you’ve heard of Crowdfunding, but I don’t think you’ve ever heard of peer to peer lending. It’s an alternative investment that I discovered just a year ago, and it has captivated me.
If you want a guide to learn about peer to peer lending and how to invest in it, read on 🙂
What is peer to peer lending?
I’m sure the first question that comes to your mind is:
What is peer to peer lending?
If we take a look at our friend Wikipedia:
Peer-to-peer lending, also abbreviated as P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders with borrowers.
It is an innovative financing method that allows companies to raise money to develop their projects, and investors to get a great return on their money.
Peer to peer lending offers great returns for investors, and an alternative financing approach for companies and people.
The return for the investors on p2p platforms is up to 20% per year.
If you compare it to the 0.1% that the savings account gives you, it’s a big difference, right?
A big advantage of p2p lending is that it’s a short-term investment, since loan terms are usually 12 to 18 months.
It is important to note that p2p lending has some risks, since the borrower (the company receiving the borrowed money) may not return the money.
That’s why it’s important to know where you spend your money, review carefully the platform and the project information, and have a diversified peer to peer lending portfolio.
If you are looking for alternative investments to investing in the stock market, peer to peer investments are waiting for you.
I’m sure you’re thinking that a 20% annual return can’t be true, but let me tell you that with peer to peer loans it’s possible 🙂
Now that you know how peer to peer lending works, let’s move to the next section!
How can peer to peer lending returns be so high?
These high returns are possible because p2p companies usually offer their services online, reducing their expenses and providing their financial services in a cheaper way than traditional financial institutions (banks).
As a result, lenders (investors who lend money) can make higher profits compared to traditional savings and investment products offered by banks, while borrowers (company/person borrowing) can borrow at lower interest rates.
In my opinion creating a peer to peer investment portfolio is one of the best ways to earn passive income.
Peer to peer lenders can obtain great returns with little effort.
The peer to peer lending market is growing, so don’t wory, there are opportunities for everyone.
P2p lending is an innovative finance service that has been operating for a few years. In my opinion it has come to stay, given it has found its niche in providing services for companies, entrepreneurs and investors.
Crowdfunding vs peer to peer lending
It is very common to confuse crowdfunding with peer to peer lending. People often think p2p is a type of Crowdfunding, and it’s not.
Crowdfunding means investing money in a company’s project to get a percentage of participation (share) in that project.
The goal is for the project to succeed so you can make money.
The way to make money is by selling your stake to another investor, or by the company distributing some of the project’s profits.
In the second case, the conditions for the distribution of the earnings in the event of success are agreed when you make the investment in the Crowdfunding project.
Crowdfunding is also known as Equity Crowdfunding, since you are buying a financial asset, which is the stake in a project or company.
The percentage of participation will depend on the money invested and the capital of the company.
One of the most popular crowdfunding platforms in UK is Property Partner.
There is a type of crowdfunding that does not seek the economic benefit, only a personal interest in a project. This kind of crowdfunding is donation based.
Peer to peer lending differs from Crowdfunding in that the investor does not buy a stake in the company/project, but lends money to an individual or a company.
This loan has a repayment term and a fixed interest rate which are agreed when the lender invests its money.
In peer to peer lending the investor does not need the project to succeed to make money.
Both Crowdfunding and peer to peer lending are collective financing. The investor invests his/her capital in order to get an economic profit.
I’m going to focus on p2p lending, because I consider Crowdfunding risks are higher than p2p risks.
How do I invest in peer to peer lending?
Once you’ve learned the difference between p2p lending and Crowdfunding, I’m going to tell you how you can invest in peer to peer lending.
As mentioned above, peer to peer lending platforms usually offer their services online.
Investing in p2p lending is very easy, you just need to sign up on one of these platforms and start investing.
P2P lending has grown a lot in the last years, so more and more peer to peer lending websites are now available.
In UK p2p is still taking off, with companies such as Zopa, Funding Circle and Ratesetter.
There are many peer to peer lending platforms in Europe that offer even better returns than the peer to peer lending UK platforms. I will go into more detail later 🙂
In order to reduce the risk, I recommend to diversify your investments in P2P. You should have a peer to peer lending portfolio with different types of loans and platforms.
When you invest you always have the risk of losing your capital, which makes risk management critical.
Before you access the wonderful world of p2p lending, it’s important to do a detailed analysis of where you invest your money, and diversify your portfolio to reduce the risk.
Now I’m going to talk to you about the features you should look for on a p2p lending platform, so you can invest in peer to peer lending like a professional!
It is very important to review the historic return that investors have obtained since the creation of the platform. This will depend on the projects and loan originators the company works with.
For example, my favorite UK platform, Funding Circle, has achieved an average annual return of 6%.
If you take a look at Europe, there are platforms that offer much higher returns.
My favourite EU platform, Crowdestor, has achieved an average annual return of 18%.
I know what you’re thinking…18% !!! How can that be possible?
Well, with peer to peer lending it’s possible, but it has its risks, which I will cover later.
Types of loans
The goal of peer to peer platforms is to provide funding to those companies and individuals who need money to carry out their projects.
Because of this, there are many types of loans that these platforms can offer. The most common types of loans are:
- Real estate
- Renewable energy
- Bridge loans
- Business loans
- Personal loans
- Cryptocurrency mining
Some platforms focus more on a single type, while others offer credits from all categories.
For example Estateguru focuses more on loans to carry out houses/building refurbishments.
When the borrower does not return the borrowed money within the time agreed in the contract, the loan is declared as default.
At that point the platform activates the legal procedure to recover the loan. P2P platforms typically secure each loan with a collateral.
When a loan defaults, if the borrower is not in a position to pay, it is triggered the procedure to sell the collateral and recover the money.
That’s why it’s important to know the default rate of the peer to peer platform on all the loans. This will tell you the risk of not recovering your money in the time and interest agreed.
If the default rate is 1% of all the loans, I consider it good. It means that you will only have one default out of every 100 loans you invest in.
It is also important to review the rate of delayed loans. A loan is delayed if the interest payment doesn’t arrive on time.
If it’s high, you’ll likely have a lot of loans where the borrower will take a little bit more to you.
Another important factor is the evolution of volume of loans over the months.
It is important that the p2p platform grows, offering more and more loans. This means they’re doing the right things, attracting more borrowers and lenders, thus increasing their business.
If the borrower is unable to meet the repayment obligation, the loan defaults. At that point the platform starts the procedure to recover the debt.
A safety net for these cases is the buyback guarantee.
The buyback guarantee means that when the borrower defaults, the loan originator automatically refunds you the money you invested.
It’s like having an insurance on the loan, which makes the investment safer. Even if the borrower doesn’t pay, you’ll get your money back. Perfect!
As it happens with any investment, your capital is never 100% guaranteed, you can lose money.
In this case, there is a risk that the loan originator will not be able to cover all the defaulted loans, This would mean the loan originator would go busted, filing for bankruptcy.
This happened with Eurocent on Mintos platform.
Some platforms offer a buyback guarantee, and others don’t. It is up to you as an investor to decide how important this guarantee is when investing in peer to peer lending.
Minimum investment required
One of the biggest advantages of investing in peer to peer is that you don’t need to invest a lot of money.
The minimum investment that most platforms require is usually 50-100 pounds, and some let you invest even from just 1 pound.
So, to start investing in peer to peer lending you don’t need to have a lot of money.
An important factor of p2p lending platforms is if they have a secondary market for loans.
I imagine you’re wondering: What is the secondary market?
Don’t worry, I’m about to explain it to you 🙂
The secondary market is a place where investors can buy and sell loans to other investors.
This has two great advantages:
- Liquidity: Investors who have their money invested in a loan can sell it to another investor and get their money back
- Increase loan volume: If no new loans are available, investors can invest their money in loans through the loans offered on the secondary market
The investor who sells the loan decides the price at which it will be sold. Depending on how quickly you want to sell it and if the loan has delays or defaults, the price will vary.
Let’s take a look at an example, which always helps understanding.
We have Flavio, who has invested 500 pounds in a loan that has an annual return of 12%, and the loan term is 12 months.
6 months after investing in the loan, Flavio realises that he needs to get the money back. The loan does not have any delays nor is default. Flavio puts it up for sale for 495 pounds.
Jorge is looking for new loans to invest his money, but there are none. In the secondary market he finds Flavio’s loan and he buys it, attracted by the 12% return plus the 5 pounds discount.
Both Flavio and Jorge are happy with the transaction 🙂
Flavio has obtained the liquidity he needed, and Jorge has been able to invest in a new loan at a discounted price.
It’s a win-win.
Peer to peer lending is a very new investment product, and that’s why the regulation varies depending on where the p2p company is based.
In UK, peer to peer lending companies are regulated financially by the Financial Conduct Authority (FCA).
It’s important to highlight that only the funds that you hold as cash in these UK p2p lending platforms are guaranteed by the Financial Services Compensation Scheme – FSCS.
The funds that are invested in loans are not covered by the Financial Services Compensation Scheme.
If you are not sure if the p2p company you are going to invest is regulated by the FCA, please use the FCA search register to confirm it.
The European platforms where I mainly invest are not regulated by the FCA because they are not based in UK. They are regulated by their own countries regulation financial institutions.
In order to confirm that the European peer to peer lending are registered as businesses in Europe, I use the European business register.
Taxes on peer to peer lending
The gains obtained through peer to peer loans are taxed, as it happens with any other source of income.
The amount of tax that you will have to pay will depend on the country you live and your financial circumstances.
For example, in UK peer to peer lending income is considered as interest. It’s taxed in the same way as the interests obtained on your bank accounts.
The big advantage in UK is that you can invest in peer to peer lending through ISAs accounts. This means that all the earnings obtained in p2p loans are tax free.
The con here is that you can only invest through ISAs on p2p UK companies.
If you want to invest in European peer to peer lending sites, you will need to do it outside of ISAs accounts. But don’t worry, UK Tax rules are very attractive for the investor even when you invest in European peer to peer lending companies..
If you are on the basic rate (on tax year 2019/2020 your income is below 50,000£s ), you have 1000£s allowance for interest gains. This means that if you earn on interests less than 1000£s during the tax year, you will not have to pay any taxes on those earnings. Yuju!!
You can earn up to 20% annual returns and pay no taxes on it. How does a 20% return sound compared to the 1% offered by the cash ISAs?
Does 20% return sound appealing? Keep on reading!
Best peer to peer lending: UK and Europe
Previously I talked about the most popular peer to peer lending platforms in UK. Now let me put them nicely in a list:
The returns offered by these platforms vary a lot from one company to another one. Capitalrise is the one that offers the highest returns, around 8-12% per year.
The others offer between 4-6% annual returns.
I have to admit I am more familiar with the european peer to peer lending companies, since I have been investing in them because the returns are much higher than in the p2p lending UK platforms.
The drawback is that the european p2p platforms operate in euros.
I understand this adds the risk of currency devalue, but with 18% annual returns, I believe it is worth to give it a try.
I have been investing in them for over one year, and I couldn’t be happier!
If you use Revolut, you can transfer pounds to euros without paying any fee. It’s 100% free!
After one year investing, these are my best peer to peer lending companies:
One of the best-known p2p platforms is Mintos. Unfortunately you cannot invest in Mintos if you are tax resident in the UK. Since I live in London, I haven’t been able to invest in Mintos.
If you don’t live in UK and want to start investing in Mintos, register here!
Peer to peer lending advantages and disadvantages
Now I would like to talk to you more in depth about the pros and cons of investing in p2p lending.
The great advantages of peer to peer lending are the high returns you can obtain (up to 20%) and the short term period required to obtain these gains (typically 12-18 months).
The biggest disadvantage on p2p lending is the risk of default.
What is the level of risk of peer to peer lending?
The level of risk you assume will depend on the analysis you do before making your investment.
Reducing the level of risk when investing in p2p lending is simple, just follow the steps below.
Invest in secured loans
As we have mentioned before, the risk of default is based on the borrower being unable to repay the borrowed money.
Most peer to peer platforms offer loans that are secured by a collateral. The value of the collateral is always greater than the amount of money on the loan.
The value of collateral is estimated by a valuation analyst, who is independent of the peer to peer lending company.
In the event that the borrower is unable to repay the credit, the collateral will be sold to recover the money.
It is very important to invest in p2p loans that are always insured by a collateral.
I do not recommend to invest in unsecured loans, since it has a higher risk of losing money.
As we have just seen, the buyback guarantee ensures that the loan manager will refund your money in case the borrower can’t pay the money back.
One of the best ways to reduce the level of risk is to invest in loans with buyback guarantee.
Invest in multiple peer to peer lending platforms
Another way to reduce your level of risk is to diversify your investments. To do this you need to create a diversified peer to peer lending portfolio.
It is very important that you do not invest your entire portfolio on a single p2p platform.
If you make all your investments on a peer to peer lending platform, you’re exposed to that platform having problems and your portfolio being very impacted.
You need to diversify your portfolio by investing in various peer to peer platforms. If a platform starts to have financial problems, the impact on your portfolio will be smaller.
Distribute your money on several loans
Within each platform, a good way to reduce the risk of default is to invest in different loans.
When you split your investment in many loans, if one loan defaults the impact on your portfolio will be small.
If you only invest in one loan and it defaults, your entire investment in that platform will be impacted, and you will have to wait for the debt recovery procedure.
Check out the p2p platforms you invest on
You should always check that the p2p lending platforms you invest in are safe.
I have previously mentioned that it is important to review the average return of the platform and its default rate. In addition, it is important to look up on internet for any mention of scam on any website or investment forum.
Peer to peer lending is an alternative and recent investment vehicle, it only started a few years ago. That’s why many of the p2p companies were founded 2/3 years ago.
P2P companies don’t have a long history, so it’s important to review the peer to peer lending companies you invest in are doing things right.
If you spot anything unusual, contact support to see if they can give you a proper explanation. If you’re not convinced by his response, you should not invest in that platform.
Another important security check is to withdraw money from the peer to peer lending platform. You should always test that the withdrawing money procedure works before starting to invest in the p2p site.
Conclusion on investing in peer to peer lending
In my opinion peer to peer lending is a great investment product. It’s having a huge growth, attracting many new investors, and I think it’s going to keep growing in the next years.
A good way to improve your personal finances is to start investing in peer to peer lending.
For me it is an essential investment vehicle on my path to financial freedom. That’s why 30% of my portfolio is invested in peer to peer lending.
Peer to peer lending can give you high returns and help you on your journey to become rich.
If you want to know more details about my portfolio, check out my April 2020 portfolio analysis.
As it happens with any investment, there are risks. The best way to reduce the risk is to look up information about the platforms and loans where you invest, thus increasing your level of knowledge.
Warren Buffett said:
The best investment you can make is in yourself
If you invest in training and improving your financial education, it will always be a successful investment 🙂
More Articles about Investing in Peer to Peer Lending
If you want to know more about investing in peer to peer lending and making money with it, check out the following posts:
- Crowdestor, the best p2p lending platform
- Estateguru Review
- Initial guide to invest in the stock market
- Portfolio performance analysis in April 2020
Congratulations on finishing my introduction on investing in peer to peer. I hope you can now understand what peer to peer lending is, how it works, and the potential it has to make money for you.