In a banking climate where bank interest rates are just slightly above 0% and government bond yields are not much better, savers have been looking for ways to earn a better return on the savings without the volatility of the stock market. One option is to make money with peer-to-peer lending. Should you consider peer-to-peer lending?
What is Peer-to-Peer Lending?
Peer-to-Peer lending is still a relatively new concept in its current form. While “microlending” has always existed as friends have lent money to friends in times of need for millennia, the Internet has made it possible for the average person to lend or borrow money from another human without the help of a bank.
Borrowers with fair credit might prefer Peer-to-Peer lending can be a good option as it doesn’t have the typical underwriting process that goes along with traditional bank loans. This means no credit check, fewer fees, and potentially lower interest rates.
For you, the investor/lender, you lend directly to the borrow and get to keep more of the accrued interest. When you let the bank lend your money, they keep a large portion (4.95%+) of the interest collected to pay their own expenses. That is why you might only earn 0.01% in a savings account or 1% in a Certificate of Deposit (CD) account.
How Much Money Can You Make from Peer-to-Peer Lending?
How much money you make from peer-to-peer lending depends on how much you invest and the type of loan. Borrowers that are considered less risky qualify for lower interest rates than an applicant with a history of missed payments.
If you invest in bonds, you have the option to invest in AAA borrowers with good credit or “junk bonds” that lend to borrowers that are more likely to default. You have a higher yield with junk bonds, but, there is also a much higher probability that the borrower will miss payments and you will lose the money you invested.
Peer-to-Peer platforms also grade borrowers based on their credit history, type of loan, and the amount they want to borrow. If you simply want to earn a steady income with minimal risk, you can choose to only invest in “Grade A” borrowers with a solid credit history. If you want a rate of return that will mimic the stock market or beat the market, you can choose to invest in borrowers with an interest rate as high as 27%.
What Types of P2P Loans Can You Invest In?
The P2P lending platforms will let you invest in just about any type of loan. It can be a personal loan to take a vacation, repay medical debt, or refinance a home mortgage as a few examples. You can also invest in business loans. Each loan reason carries a different interest rate just like similar loans offered by a bank.
Is Peer-to-Peer Lending Risky?
Peer-to-Peer lending can be just as risky as any other investment. No investment is guaranteed to profit every single year. The odds of earning a profit with P2P lending are much higher when you invest in borrowers with excellent credit. Just like the odds of earning a profit are much higher when you invest in large cap index funds that hold positions of some companies that have been in existence for over 100 years.
The best way to limit your risk is to diversify and invest in multiple borrowers. You might even consider investing in 100 different loans.
If you have $5,000 to invest, you don’t have to find a loan request for $5,000. You have the option to invest as little as $25 in a “note.” For example, if somebody needs $10,000 to consolidate their credit card debt, you can only choose to invest $25 for that particular loan in case they fail to make the monthly payments.
Using a loan screener can help you easily find what loans and borrower meet your criteria so you do not accidentally invest in a risky borrower or loan. The lending platform should also tell you the average default rate for the borrower grade to help you make an informed decision as well.
Where to Start Peer-to-Peer Investing
These are a few of the largest peer-to-peer lending platforms to choose from.
Lending Club was founded in 2007 and is the largest peer-to-peer lender. Individual borrowers can take out a loan from $1,000 to $35,000. According to Lending Club, the average annual rate of return for most loan notes is 5% to 7% for Grade A to Grade C borrowers.
Investors pay a 1% transaction fee for all received payments. You do not get paid if the borrower doesn’t make a payment.
Prosper is the original U.S. peer-to-peer lending platform started in 2006. Borrowers have the option to apply for a 3-year or 5-year loan for personal loans of just about any reason. Investors will pay an annual fee of 1% based on the outstanding principal balance of your loan notes.
You might also consider Prosper as they claim to have the highest average applicant credit score, 710, of all the peer-to-peer platforms.
One final suggestion, Upstart, takes a different approach to the loan application underwriting and investment strategy. In terms of borrowing money, Upstart also focuses on the college you attended, field of study, GPA, and standardized test scores in addition to the usual underwriting factors of your FICO score, credit history, and current income.
For investors, you invest in a pool of loans based on a specific investment grade. Instead of individually choosing each loan you want to invest in, Upstart will randomly assign you loans for borrowers and loan types that meet your lending criteria.
This “hands-off” approach might seem a little riskier, but, there are a few upsides. Investors do not pay any fees as the Upstart makes their money from the origination fees charged to the borrow. If a loan defaults, Upstart will refund you (the investor) your portion of the investment from the origination fee.
Although Upstart is still a relatively new company that has only been around since 2014, 91% of all their loans are in “current” status. This is the lowest delinquency rate of all three lending platforms mentioned in this article.
It is possible to make money with peer-to-peer lending. Since the concept has only been around for a decade, the long-term income projections are not as in-depth as a traditional bond or stock investing. But, two of the largest companies have been in existence since before the Great Recession, it is safe to say that this investment strategy is a profitable alternative. As with any investment, profitability required diversification.