Investing in loans such as consumer loans, car loans, mortgages, real estate development and much more has for a long period of time been for the banks. This period is now over with the investment type called P2P lending also known as crowdfunding. You now have the opportunity to join the business which previously only belonged to the banks and credit unions. My statement is: Invest in loans!
Investing in loans is one of the most profitable investment vehicles, currently. Many investors see returns in the plus twenty percent and many averaging around 11%. Diversification is also an option as it is possible to invest in mortgage loans, car loans, consumer loans, business loans and much more.
There are many reasons why you should invest in loans. However, there are also some reasons why you shouldn’t. Investing in consumer loans and real estate is among the most common. I have invested in over 6 platforms that offer loans and I will share my knowledge as to why you should invest in loans.
Why Invest in Loans?
While you may not think about it when using platforms like Kickstarter and IndieGoGo, those types of platforms are actually crowdfunding platforms. The purpose of Kickstarter and alike platforms is to build businesses where the return for your “investment” is a product (called rewards-based crowdfunding).
What makes P2P lending different from rewards-based crowdfunding is that instead of a product you get interest as a return.
The banking industry has long enough been making big profits from mortgage loans and credit card loans. However, this was an exclusive investment made by the banks. Investing in loans has been made publicly available through the term called peer-to-peer lending or P2P lending. The first P2P lending company was founded back in 2005. Since then the P2P lending platforms have been blooming around the world.
Researchers are to this date still unsure whether P2P lending will replace banks or if they will serve a market that cannot be fulfilled by the banks or if they simply will take a market share of the banks.
The banks run with high-interest rates on their credit cards. According to Nerdwallet the average credit card interest rate is 16,97%, furthermore, the average credit card interest has increased by 35% over the last five years. According to Finder the APR on business loans are between 6% and 60%.
The banking industry has done this business model for many years, so why shouldn’t you?
Advantages of Investing in Loans
Investing in loans is a great opportunity in the new space of FinTech. Investing in loans can offer returns of double digits. When comparing to stocks and bonds that is quite a significant upside. On some of the biggest platforms like Mintos the returns vary of 5% and all the way up to 18%. On smaller platforms like Crowdestor, the returns go over 30 on rare occasions.
The returns are obviously high and so what? Let me tell you! Most people are holding cash, fewer are investing in stocks, bonds, etc. Whether you are into cold cash or stocks you can join the lending game. There is no special requirements, other than the requirements set by the platforms issuing the investment loans.
For the people already investing P2P lending is another good way to diversify your portfolio. Especially if you are caught in the recommendations from your bank. Having P2P lending in your portfolio is a great way to diversify across other investment vehicles but also across loan types and industries. When investing in loans you can invest in loans from game developers, consumer loans, invoice financing, industrial production, real estate, real estate development and much more.
Investing in loans also gives a predicable cash-flowing asset. Usually, interest is paid monthly. On some occasions, it varies if the monthly payment included both principal, interest or both. However, as a rule of thumb interest and principal is paid monthly over a fixed duration of time.
The monthly repayment with interest and principal allows for quick reinvestment which helps the compounding interest. One of the major benefits with P2P lending is that the loans do not jump up and down in value (like stocks), hence the value of your portfolio is increasing exponentially due to the compounding interest.
The last major advantage is the low cost of entry. To my knowledge, there are no P2P lending platforms that require investors to pay for their services. This means that no matter your wealth you are welcomed to any platform and start investing.
There are some minimum investments at most platforms. However, they are between €1 and up to €100. However, P2P lending platforms do rarely have any fees, meaning that if you invest €100 you get €100 back plus the interest.
Disadvantages of Investing in Loans
Now I have sold the dream of double-digit returns and all its glory with instant compounding interest and so on. But ain’t there any risks in P2P lending? Of course, there is… There is with any type of investment, whether it would be stocks, bonds, CDs, etc.
First of all the P2P lending market has yet to experience a recession. I mentioned earlier that the first platform was founded in 2005. However, at the time of the 2008 recession only 3 platforms where operating. In 2016 there were over 4.000 P2P lending platforms in China alone. Therefore, the P2P lending market might be supersaturated like the online business environment in the dotcom bubble of 2000. However, we cannot know before the recessions have tested the P2P lending industry several times.
Secondly, investing in loans is a new type of investment. Therefore, there is a lot of uncertainty about the future of P2P lending. The stock market has been through numerous recessions, whereas the P2P lending market has yet to be in a recession as a developed industry. It is also important to remember that with any new businesses/industries/investments there are risks involved. Take blockchain and drones as an example. Blockchain has seen major use in many industries for transparency in the supply chain. It has also been used to create cryptocurrencies. But as we all know, cryptocurrencies are volatile. Drones have also seen major use-cases in a lot of industries, from real estate agents to helping off-shore wind farm transporting tools. While it is a great tool it also posses a lot of risk for the surrounding people, if the drone falls from the sky it could have fatal consequences. Therefore, drones are under heavy legal regulation to improve safety.
My point is – Everything new, is new. Therefore, we do not know the consequences and we will regulate and adapt as the events happen along the way.
When making the jump into investing in loans you should consider your risk tolerance. Therefore, you should not jump in and invest 100% of your money into P2P lending, if you are not prepared to lose it all. However, if you invest 5%-15% of your total portfolio in P2P lending you are diversifying and earn double-digit returns in a predictable pattern.
Basics of Investing in Loans
When you have thought about the reasons to invest in loans and the risks associated with it you can go sign up to different platforms and learn the basics. You can visit my page with an overview of platforms.
Investing in loans is a very simple idea. You lend your money to someone that needs money. However, there are so-called P2P lending platforms that act as middlemen. These P2P lending platforms will then either fund loans on their own behalf or have contact with loan originators which can offer loans that you can invest in.
In the picture above is an example of the Mintos P2P lending platform. Mintos is one of the P2P lending platforms which has contact with loan originators. The loan originators then offer the loans which you can invest in. The loan originators are credit unions that offers loans to borrowers. The loans are then published on platforms like Mintos, where the loans are funded by the investors (you and me) for an economic return.
Investing in Consumer Loans
Consumer loans are typically a month-long investment. This means that if you have a short time horizon on your investment strategy you can use consumer loans as they are usually repaid in full within a single month.
Investing in Real Estate Loans
The second-largest loan type in P2P lending is real estate. There are essentially two types of real estate P2P lending. The first type is the development projects. This type of real estate lending offers loans to development of new real estate projects or renovations of real estate. The real estate development loans are offered through Grupeer, Crowdestate, reinvest24, Bulkestate and many more.
The seconds type of real estate lending is the crowdfunding of properties where the return is rental income. Such investments are offered by BitOfProperty. Investing in crowdfunding of properties are rarer. However, it is another great diversification option if you don’t have the money to invest in full real estate deals, or simply don’t wish to manage the properties.
Investing in loans has many benefits and some drawbacks. It is not a risk-free investment, however, it has some very great upsides that cannot be found in other investment types.
Going for double-digit returns, with predictable cash-flow, diversification of current portfolio and compounding interest is no shame. It should be looked at as a very good opportunity but with calculated risk according to your own risk tolerance.
Online Peer-to-Peer Lending: A Lenders’ Perspective. Proceedings of the International Conference on E-Learning, E-Business, Enterprise Information Systems, and E-Government, EEE 2008, H. R. Arabnia and A. Bahrami, eds., pp. 371-375, CSREA Press, Las Vegas 2008 https://dx.doi.org/10.2139/ssrn.1352352
Huan Tang, Peer-to-Peer Lenders Versus Banks: Substitutes or Complements?, The Review of Financial Studies, Volume 32, Issue 5, May 2019, Pages 1900–1938, https://doi-org.proxy1-bib.sdu.dk/10.1093/rfs/hhy137
Havrylchyk, Olena & Mariotto, Carlotta & Rahim, Talal & Verdier, Marianne. (2016). What drives the expansion of the peer-to-peer lending?.