Interesting Investments: Peer-to-Peer Lending

Avery-Taylor Phillips  |


We’ve discussed how investing in education can pay dividends with the next generation having necessary skills to enter the workforce, and your company, but what if investing in people actually meant monetary dividends? Peer-to-peer lending does just that — and it could improve someone’s life as an added bonus.

What is Peer Lending?

Peer-to-peer (P2P) lending, also known as peer lending, crowdlending, or social lending, is essentially what it says on the tin: lending money to another in an unsecured loan. Except, instead of a friend handing you a few bills, this is a formal business arrangement that can involve multiple people. There’s no bank involved, though plenty of companies will facilitate the online transaction as a middleman (which means you can even do it from your phone, no face-to-face meetings to evaluate borrowers necessary). It’s one way people with poor or no credit can get a loan, and it’s less predatory than a payday loan. Other loan-seekers have good credit, but would rather not deal with banks.

This sounds great if you are into being an altruistic social entrepreneur, helping people who need a hand, but what about as an actual investment?

P2P Lending Returns

We’re going to focus on two platforms, the two biggest in the US lending scene, but there are other platforms for other purposes. Prosper, one of the bigger companies managing P2P lending, has seen a fairly consistent return of about 9 percent through 2014, with a dip to 6.6 percent in 2012. Lending Club has seen a rise from 4.9 percent in 2009 to about 8 percent in 2014. All told, not bad ROIs.

Requirements

Alas, unlike investing in stocks, there are some requirements to break into the P2P lending game. The bar for entry as far as money invested is low — as little as $25, which is no more than what you would spend for a couple of people at a fast food joint — but some states have specific requirements.

First, you must be at least 18 years old, with a Social Security number, and live in an eligible state to even consider investing. Then, some states require that you have a minimum $70,000 gross income ($85,000 for California), and a minimum net worth of $70,000. You may not be able to invest more than 10 percent of your net worth. However, if your net worth is at least $250,000, there is no minimum income requirement.

Both Prosper and Lending Club offer investments via a taxable investment account, or through a tax-deferred IRA investment account.

Risks

All of this comes with a caveat: It can be risky. Don’t invest more than you can afford to lose. Borrowers can still default on the loan. Prosper, for example, has an annual default rate 3 to 4 percent higher across all grades. Lending Club has a 6 to 7 percent default rate. Obviously, riskier loans carry a higher chance of defaulting, and many new investors fail to diversify the loans they invest in.

To mitigate this, consider only investing in borrowers with higher credit scores, and not putting your proverbial eggs in one basket. For example, a $5,000 investment can be divided up into 1,000 different loans. If a few default, the others can pick up the slack. Because these are not bank-operated loans, the FDIC does not insure the money. If it’s gone, it’s gone. But as far as risky investments go, you can do far worse. And, you might just make someone’s dreams come true, whether it be a personal loan that someone needs to get out of a financial rut, or a business loan that someone needs to start their own company. Other platforms offer investments in student loans or real estate, as well, offering even more diversity for your portfolio.

You can find more information on some of the popular lending platforms here.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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