Peer-to-peer (P2P) lending is a new alternative investment, which does not look like stocks, bonds, certificates of deposits or any other classical investment. Most P2P lending platforms offer double-digit returns but is it a good investment?
P2P lending can be a good investment. Returns can easily be double-digits and typically ranges from 6%-15%. P2P lending offers a stable return which is significantly higher than bonds and CDs and does not fluctuate like stocks. It comes with risks, as P2P lending has yet to be tested long-term.
The debate about whether P2P lending is a good investment or not has many aspects which I will cover in this post.
How P2P Lending Works
P2P lending, in essence, a group of people acting as a bank. Where a bank fund one big loan, P2P lending’s concept allows many investors to fund big loans together. In other words, using P2P lending the investors can collectively fund loans and get a reward that has previously been exclusive to banks and credit institutions.
The term “Peer-to-peer” and “lending” represent the main aspects of the concept. Peers are exchanging funds in essence without middlemen. However, P2P lending platforms act as middlemen but the process is highly automated, thus fees and general costs are much lower than issued by banks. This is also what makes it attractive for borrowers looking for funding.
When looking visually at how P2P lending works (because that is often easier), you will have the borrowers on one side the P2P lending platforms in the middle and on the other side you will have the investors.
The borrower is an individual or business who is in need of a loan. The borrower then requests a loan with a loan originator or a P2P lending platform. The loan originator or P2P lending platform post the loan for funding. The loan is now available for the investors to invest in. The P2P lending platform will conduct a loan agreement between the borrower and the investor. The borrower will pay interest and principal as agreed to the investor for funding the loan.
P2P lending solves a problem for the borrowers:
- Borrowers need money to grow business
- Access to alternative, cheaper sources of finance
- Investors validate a business idea and advertise new product or service
- Helps start-ups grow and reach the next stage of funding (e.g. bank loans, venture capital)
- Borrowers need money for expenses
- Consolidate debt to lower interest rates
- In need of fast capital
Borrowers of P2P lending are typically individuals/businesses which could not get a loan through their bank or credit institute and therefore is seeking alternative funding. Others do it out of philosophical beliefs such as wanting to avoid the banks and government and have the financing be a kind of circular economy.
The European Commission also states that smaller businesses are pinched between funding options. P2P lending enables these small businesses to get funding for further development. In the startup period of a business, both banks and venture capitalists want to guarantee their return on investment (ROI), thus also hesitating to provide funds to the startup business.
Typically startup businesses have to rely on their own, family, or friends funds. In startups with very strong salespeople or problem-solving solutions can attract angel-investors in the earlier stages. However, not all businesses or projects are revolutionizations, hence not everyone can attract angel investors. This is where P2P lending (also known as crowdfunding) is a good alternative.
P2P lending solves issues for investors:
- No price fluctuation (Like stocks)
- Higher returns (In contrast to bonds and savings accounts)
- Invest in promising projects for a good return
P2P lending investors have some very lucrative returns compared to the average stock return, bonds, CDs and savings accounts. P2P lending offers returns between 6%-22% depending on the borrower, platform, circumstance, collateral, etc.
P2P lenders also benefit from a stable investment long-term where stocks can fluctuate, and in financial downturns decrease a lot. The invested value of a loan will only decrease if the borrower defaults.
Looking at the returns between the asset classes it is clear that P2P lending is lucrative when platforms such as Crowdestor offer up to 34% return on investment, and the more conservative platforms like EstateGuru and Viainvest returns 8-13%. Personally, I made a return of 12,6% in 2019. However, this cannot be compared to a 20-year period.
What Returns To Expect
There are many variables in determining the interest of a loan. However, as a P2P lending investor, the expected return should be between 8%-12% on average.
P2P lending comes in many forms. There are short-term loans, personal loans, business loans, project loans, bridge financing loans, real estate development loans, and much more. Each loan type has its separate risk categories, which also means the different loan types have different returns.
Impact on Returns – Collateral
Besides the loan type the collateral also has a huge part in the expected return. Platforms which demand collateral from their borrowers (EstateGuru) will typically reduce the risk, but also reduce the return. Where platforms such as Crowdestor, Mintos, PeerBerry, Viainvest, etc. do not require collateral from the borrowers and therefore the returns can be significantly higher.
While platforms such as Viainvest and Grupeer have some loans with collateral those loans are offered at much lower interest rates compared to their counterparts without collateral.
On platforms such as EstateGuru demanding collateral to fund projects, the expected return is between 7%-10% on average. Whereas, platforms that do not demand collateral can expect to return between 10%-15% on average.
Impact on Returns – BuyBack Guarantees
There are multiple platforms offering buyback guarantees. Typically there are 2 types of buyback guarantees:
- Buyback the loan when it is X amount of days late.
- Investors can sell the loan directly back to the platform.
Buyback guarantee number 1 is an industry-standard currently. Every platform is expected to have this feature. There are only a few platforms that do not offer the buyback guarantee. However, buyback guarantees can be lethal for a platform or loan originator. If a large portion of the borrowers fails to repay the investors, the platforms or loan originators have to cover the losses. If the loan originators or platforms go bankrupt the investors will also lose their money. therefore, a buyback guarantee is only good when the loan originators and platforms are in good financial standing. It is also, therefore, I include financial statements in my P2P lending platforms reviews.
The buyback guarantee number 2 is just as dangerous if a big portion of investors panic and want early termination of their investments. However, during good financial periods, the buyback guarantee can ease the barrier-of-interest for the investors. However, P2P lending platforms such as Monethera had to stop issuing buyback guarantees as investors panicked by the disappearance of 2 P2P lending platforms in December 2019 and January 2020.
The buyback guarantees have advantages and disadvantages. Firstly, whenever a loan is late it is bought back and the investor will not lose any money – Good. The platform or loan originator then has to “eat” the loss – Bad. This will lower the overall profit margin offered to the investors, in return it does not pose risk to each individual investor.
If investors sell back their loans for early termination it usually comes with a penalty. This penalty can be a fee from the invested amount or loss of accrued interest. An example is Fastinvest. They provide both the buyback guarantee 1 and 2. If a loan originator has not paid the investor within 60 days, the loan originator is forced to repurchase the loan from the investors. Furthermore, an investor can at any given day sell all loans back to Fastinvest at the loss of all accrued interest on the active loans.
The conclusion is that Buyback guarantees are only as good as the financial state of the platform or loan originator.
Popular P2P Lending Platforms
There are multiple popular P2P lending platforms in Europe. However, to get an unbiased opinion on which platforms are the most popular, I found a poll made on a Facebook Group called P2P Investment Fellows. The top 5 rated platforms where:
- PeerBerry (11,51% average return)
- Mintos (11.89% average return)
- Grupeer (13,15% average return)
- EstateGuru (11,88% average return)
- Crowdestor (15,3% average return)
Personally I have been invested in Mintos, Grupeer, Swaper, LenderMarket, EstateGuru, and Fastinvest. So far I can recommend Mintos, Grupeer, Swaper, LenderMarket, and EstateGuru. I have had a good experience with Fastinvest, but over a years waiting for publicizing loan originators has broken my trust in the platform. However, they have never missed a payment and withdrew my money fast and in full.
What Are The Risks?
Generally, I see 7 different risks in P2P lending. When looking at the risks associated with investing in P2P lending it is clear that some of the risks are no different from accessing a stock. However, P2P lending is a little different, but the mindset is the same.
Rule number 1: Never lose money.
Rule number 2: Don’t forget rule number 1.Warren Buffett
These 7 risks of P2P lending are:
- Platform diversification
- Loan originators/Borrowers
- Understanding the Platforms
- The Financial State of the Platforms
- Regulation and Legislation
- Haven’t Experienced A Recession
- Psychological Risk
1. Platform Diversification
P2P lending is a tempting investment opportunity since it can make a double-digit return with minimal efforts. However, it can become blinding when platforms offering +12% returns. Thus making us go all in. However, it is important to diversify across platforms, loan originators/borrowers, loan types, countries and even currencies. What to diversify between depends on the individual risk tolerance of the investors. However, just like with stocks, bonds, etc. diversification is key.
2. Loan originators/Borrowers
Some platforms act as the loan originator themselves (such as EstateGuru and Crowdestor) and some platforms are a middleman for connecting loan offers to investors (such as Mintos, Swaper, Viainvest, and Grupeer). The difference is that platforms that act as loan originators are also dependent on the success of their borrowers. Whereas, the platforms acting as middlemen does not have the same success incentive.
The platforms which act as middlemen for bridging loan originators and investors can always go find new loan originators. Whereas the platforms which act as loan originators need the borrowers to succeed in order to get paid themselves.
3. Understanding the Platforms
Understanding the platforms are important when evaluating the risk. Specifically the obligations of each platform. Some platforms make no guarantees that you will get your return on investment, while other platforms try their hardest to give you the expected return. The 2 most common running of platforms, is the acting as a loan originator, and being the middleman bridging loan originators and investors. In the following two paragraphs I will give an example of each.
Middlemen Bridging Loan Originators And Investors
Mintos is a platform that acts as a middleman between loan originators and investors. The loan originators have borrower loan requests which are posted on the platform through the loan originators for the investors to fund. Most of these loans are offered with a buyback guarantee, which is an obligation of the loan originators.
If a borrower fails to pay the loan originator (and therefore the investor) the loan originator has to buy back the loan from the investor and accept the loss. Mintos seems to be making money based on a subscription/fee charge of the loan originators (indication found in Mintos financial statement 2018). This means, that Mintos is not liable for the bad borrowers, and their “only” incentive is to get more loan originators to the platform while satisficing the investors.
Platforms Acting As Loan Originators
EstateGuru is a platform that acts as a loan originator itself. Borrowers contact them directly. EstateGuru makes its own due diligence and makes its money from the borrowers. On EstateGuru under the price list section, it is possible to spot the costs for the borrowers.
EstateGuru has a fee between 2,5%-4% of obtaining the loan and annual administration fee of 0%-2%.
EstateGuru is unlike Mintos dependent on whether the borrower has money to cover fees.
4. The Financial State of the Platforms
While the financial state of a platform like Mintos does not directly impact your investment (“As Mintos does not issue loans, you still own the claim rights against the borrower or lending company, and the appointed manager will help transfer all outstanding payments”). However, if Mintos goes bankrupt, you can only hope the loan originators have the liquidity to buy out all outstanding payments.
Platforms like EstateGuru can only exist if they make money. If EstateGuru should cease to exist the collateral agent will hold and manage the collateral claim which you have against the borrowers. This collateral can be sold to recover the investments partial or in full, which is less risky compared to platforms like Mintos, which acts as middlemen without collateral.
5. Regulation and Legislation
In financial industries, regulation is strict to prevent money laundering and embezzlement. Furthermore, when regulation is made for new industries the regulation can seem a bit “fluffy”. Therefore, following the regulation and legislation within P2P lending is important as it can have a significant impact on your investments.
Whether it is tax laws, interest rate laws, Know Your Customer (KYC) laws, etc. it is important to stay up to date. This will enable you to spot platforms that do not seem legit or according to laws.
6. P2P Lending Haven’t Experienced A Recession
The P2P lending industry has yet to be in a recession. Currently, LendingClub and Zopa have experienced periods with financial distress. Both platforms managed to stay profitable (at least for the investors), proven with the pictures below.
While both platforms returned less than they have the previous and following years, neither had a negative return.
7. Psychological Risk
The biggest risk currently, in P2P lending is the greed for the double-digit returns. P2P lending is very lucrative, but it can be dangerous to throw all eggs in one basket. The Asian market has experienced a P2P lending crisis, which got the number of online banking companies down to 1.200 from 6.000.
When starting a P2P lending portfolio or investing more funds, it is important to remember that the platform that provides the highest interest rates is not necessarily the best platform for long term security. Throwing all eggs in one basket (going all-in) in a platform like Crowdestor just because they provide returns between 15-34% is very risky. Mostly because they focus on business loans in a small variety of countries.
P2P Lending Disadvantages
P2P lending has both advantages and disadvantages for the borrower. When looking at the interest rate offered by the platforms, the interest rates can be both better and worse than the rates offered by credit institutions and banks. This is clearly illustrated in Mintos’ loan listing. The column called “Borrower APR” (Annual Percentage Rate) illustrates interest rates from 0% and up to +100%. This means that some loans can compete with credit institutes and banks.
When the APR is a very high percentage it is also an ethical issue. E.g. a personal loan with a 100% APR on a €1.000 loan. How should an individual in need of solely €1.000 be able to pay a principal of €1.000 AND interest of €1.000 back?
The space is currently not very regulated, and the only specific regulation that applies to P2P lending platforms is KYC (Know Your Customer) and AML (Anti-Money-Laundering). The KYC and AML legislation is in place to prevent money laundering and financing of illegal activities.
P2P Lending Advantages
From an investor’s point of view, a small exposure towards P2P lending can help diversify the overall portfolio. Furthermore, most platforms allow you to start investing for €10 or less per loan. This makes P2P lending available for everyone wanting to invest.
Where stock prices can cost hundreds of Euro for just 1 share, it is possible to own a part of the loan for just €10. The price of a stock fluctuates pays low dividends and is very dependent on the yearly financial statement. Whereas P2P lending does not fluctuate, it pays a stable interest and is not dependent on any financial statements.
Furthermore, it is easy to have control over the loan portfolio. Most platforms offer auto-investment which is adjustable. These “auto-invest” options can enable investors to customize their portfolio to risk tolerance. I get a +13% return on my Mintos Auto-Investment Strategy.
Conclusion – Is P2P Lending A Good Investment
The idea of many people funding a lot of different loans with a middleman that automates the process is a new concept – It is called P2P lending. The concept is relatively easy to understand and due to the low barrier to entry with double-digit returns are also what persuades many to invest.
The investors can expect a return between 8%-12%. The return all depends on which loan type and if it has a collateral or buyback guarantees. The most popular platforms among the P2P lending community returns between 11,5%-15,5% (before defaults and late payments).
With every investment comes risk. This is no exception for P2P lending. The risks can be summarized to common sense, understanding the platforms, and keeping tabs of the current legislation.
There are some clear disadvantages of P2P lending. Firstly, it is poorly regulated, secondly, it can act unethically. However, the advantages are the low barriers to entry, no price fluctuation, high returns, and high control of the loan portfolio.
In conclusion: P2P lending is a good investment if done properly. Diversify, follow laws, use trusted platforms, and using common sense is the way to be successful in P2P lending. Consider your risk tolerance and invest accordingly.