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Many investment management firms began telling their investors in 2016 that they could expect returns below 5 percent after factoring in inflation for the next 10 years. If you’re like other investors, numbers that low probably have you wondering what other options are available that may make better use of your money.
One investment option that has become quite popular is peer-to-peer (P2P) lending. This form of lending connects you with borrowers in need of loans, and it’s developed a reputation as one of the hottest investment options on the market.
Some investors have gotten returns of 10 percent annually with P2P investing. But how can you get similar or even better results?
How P2P Investing Works
The P2P lending industry began in the United States in 2006, and it provides a way for borrowers to obtain loans funded by investors. The typical borrower is a business owner or an entrepreneur who either can’t obtain a loan through a financial institution, or can’t obtain a loan without a sky-high interest rate.
For example, a borrower may be planning to launch a martial arts school in his area, but he doesn’t have the money to cover the up-front costs. The banks and credit unions he has visited all require at least one year of financial records for a business loan, and he hasn’t even been in business that long. So he goes to a P2P lending marketplace instead.
On your end, you’re playing the part of a bank. You can issue loans for certain amounts, and you do it entirely online through a P2P website.
P2P investing has two significant benefits for you.
The first is that there are almost always many different investors contributing a certain amount to each loan, so the risk is shared between all of you. Instead of having $5,000 committed to one loan, you can commit a few hundred dollars to a dozen loans.
The second is the returns. The APR on P2P loans can reach 24 or even 35 percent, which earns a hefty return on your investment. However, you generally want to avoid loans on the upper end of the APR range to minimize your risk.
Making Money Through P2P Investing
You know how P2P investing works, but you still need the right strategy if you’re going to actually make money doing it. Follow these tips to give yourself the best chance of success:
Choose the Right Loan Platform
There are quite a few sites out there that connect borrowers and lenders for P2P loans. But to stay safe, you should pick one with a strong reputation in the industry. Prosper was the first P2P lending platform that launched in the United States, and The Lending Club came shortly after that. Both of those platforms are among the most popular in the nation, so check them out first. If you’re in the United Kingdom, Zopa is the top platform available.
Check Every Borrower’s Risk Score
P2P lending platforms give all their borrowers a risk assessment score which is determined by their credit scores. Borrowers with lower credit scores obviously must pay higher interest rates, which brings the potential for a greater return on your money.
Avoid the temptation to split your money up among several high-risk loans based on the misconception that most of the borrowers will repay their loans. They have low credit scores for a reason, and the reality is that most of them won’t repay what they borrow.
If you are going to invest in high-risk loans, make those a small part of your lending portfolio. The majority of your loans should be more conservative to avoid losing money.
Consider Payment History
After checking risk scores, look at each borrower’s history of repaying loans. Past behavior is the best predictor of future behavior, so the ideal borrower is one who has borrowed and repaid loans in the past. Keep the amount of loans you issue to first-time borrowers to a minimum.
Even if the borrower has a high credit score, you’re still taking a higher risk by lending to them. Stick to borrowers with a strong track record of repayment.
Look at More Than Just the Numbers
P2P investing is about more than just putting in some money for a set return. The borrowers on the other end of the loan are real people looking for funding for their businesses. If those businesses fail, either due to their own mistakes or because the economy tanks, there goes any chance of repayment and a return on your investment.
Just like you would with any other type of investment, perform your due diligence. Analyze the risk that comes with each venture, and keep up with the news related to your investments and potential investments.
Take Advantage of P2P Investing Tools
You can find plenty of tools designed to help you choose the right P2P investment opportunities. Features of these tools include filtering out high-risk borrowers, providing information on economic trends in specific industries and calculating risk scores. Make the most of the tools that are on the market so you can make sound investment choices.
P2P lending provides an exciting opportunity that benefits both borrowers and lenders. The borrowers can get funding that they otherwise wouldn’t be able to obtain, while investors can collect high returns on their money.
Just like any other investment, P2P investing has its risks. If you lend money to the wrong borrower, you could end up losing it. However, being able to spread your money out across a wide range of loans reduces your overall risk. You can also decide exactly how much risk you want to take by looking at the risk scores of each borrower.
You’re essentially taking the place of a bank as a P2P investor, which means you need to think like a bank would when evaluating potential borrowers. The benefit of your position, though, is that you can issue risker loans than a bank would to get better returns.
Should you take the leap into P2P investing? You won’t know if it’s right for you until you give it a shot.