The main question most people who are new to P2P lending ask is whether it is worth it, and how safe it is. While it is difficult to say how risky it is there are some indications that can help bring some light to the topic. Whether it is worth investing in P2P lending or not depends on the risks you are willing to partake.
P2P lending is seen as a risky investment, and for the most part, this is true. However, there are a lot of ways to mitigate the risks of P2P lending. Furthermore, if the banks’ main income is from lending money, don’t you think you can make a profit as well?
P2P lending is a growing industry. Europe is currently the smallest provider of crowdfunding and P2P lending operations. My best guess is that the interest rates are generally low in Europe, and due to the EU setup countries in the EU can utilize each other, having a smaller need for cross-border loans.
In this post, I will do a P2P lending review. I will discuss the pros and cons of P2P lending as an investment. I have used P2P lending in over a year and I will share the results with you in this post.
What is P2P Lending?
The concept of P2P lending is quite simple. A lender (investor) funds loans to borrowers through third-parties (often referred to as platforms). The platforms have agreements with loan issuers or act as a loan provider themselves.
The idea is that businesses and individuals can lend money through P2P lending platforms or loan originators who fund their loans through P2P lending platforms. There is a myth that P2P lending platforms are only serving lenders who cannot get a loan at their bank. However, it has come to my attention that loan originators and P2P lending platforms are competing for the loans, meaning that the borrowers can negotiate lower interest rates.
There is also another correlation to this myth. Small businesses typically cannot get loans, because their products are not developed or in the prototype stage, which makes the investment case for the banks weak. The European Commission has made a visual report which can be found here. In the report the European Commission includes the growth of a company compared to the investments needed.
The graph clearly illustrates why P2P lending (crowdfunding) is needed for small businesses. Furthermore, small businesses might not have gotten to a point where they have retained profits, hence crowdfunding might be needed even earlier in the growth stage.
Types of P2P Lending and Crowdfunding
There are generally seen three different types of P2P lending/crowdfunding.
|Equity crowdfunding||Rewards-based crowdfunding||Peer-to-peer lending|
|Profitable growing business||✓||✘||✓|
|Established and steadily growing||✓||✘||✓|
|Established stable business||✓||✘||✓|
|Launching new product/service/brand||✓||✓||✓|
|Expanding into new territories||✓||✓||✓|
|Investing in new facilities||✘||✘||✓|
|Looking to refinance||✓||✘||✓|
|In need of capital restructuring||✓||✘||✓|
- P2P lending (crowdlending): Direct alternative to bank loans
- Equity crowdfunding: Selling a stake of a business to a number of investors in return for an investment
- Reward-based crowdfunding: Donating funds to a project with the expectation of a non-financial reward in return
Whether you are a small business or individual you can seek loans just like you would at the bank. While P2P lending has its benefits, it is not always the best option.
P2P lending can typically benefit from lower interest rates. Banks and credit companies have to cover the costs of physical locations with employees, call centers, ATMs, and much more. Whereas P2P lending platforms only have to pay employees and connect to loan originators. This allows for competitive low-interest rates.
This also applies to the origination fees. When you take out a loan, you typically pay X percent of the loan as a service cost. P2P lending platforms can offer lower origination fees due to the overall lower expense structure.
To beat the myth with people that are rejected at their bank, of let me state something from thebalance.com: “Credit matters, but blemishes are okay…You need a decent credit to get approved – a FICO score in the mid 600s or higher is best-but P2P might give you more options…”. While 600 is not the highest FICO score, it is not in the low range of the scale ranging from 300 to 850. According to Investopedia a credit score in the mid 600s is considered fair to good. This means you are likely to get a loan.
Lending money has some risks, however, it also come it great upsides. The general upsides can quite significantly outweigh the risks of lending through the platforms. The highlight the advantages of P2P lending I have made small sections below that each highlights and discusses the benefits of P2P lending, while I will be discussing the risks of P2P lending later in the post.
The Flexibility of P2P Lending
P2P lending is flexible. You can go for low returns and you can go for high returns. You can go for platforms that offer a higher interest like Envestio. If you want to have higher security of your funds you can go to Mintos and select their A+ rated loans. The two platforms offer two sides of the P2P lending spectrum. Envestio offers high returns, no buyback guarantees if the borrowers do not repay, whereas Mintos offers loans that are graded after their internal scale for investor safety, buyback guarantee and a lot higher diversification.
That is not to say that you should not invest in high yielding platforms like Envestio. However, it should be an opportunity to increase your returns. Just like you do not put all eggs in one basket in the stock market.
The Costs of P2P Lending and P2P Lending Platforms
The costs of P2P lending for the investors/lenders are typically zero. 100% free investing. Now that is something other investment types does not offer. Whether you are into stocks or real estate their are fees or costs associated with them.
However, with P2P lending the borrowers typically pay the loan origination fees.
On some platforms you are deducted a few percentage to pay for the operations. BitOfProperty as a platform who takes 10% of your rental income from the investments to pay for their costs.
The investor is in control of the investments on the platforms, meaning that you get to chose which loans you think is right for you. On popular platforms like Mintos and Grupeer, you even get to choose which loan originators you want in your portfolio.
E.g. on Mintos I have made an auto-investment strategy based on loan originators. Here I have only selected loan originators which has a B rating or higher, pays interest on delayed loans, and has a buyback guarantee. This ensures that I get my money, if I don’t there are additional interest so I avoid cash-drag, etc. I am in control of the investments.
How Safe is Peer-to-peer Lending?
You will never hear anyone claiming that P2P lending is safe. If you do, don’t trust them. While I am really bullish on the use of P2P lending, there are factors that make P2P lending “risky business”.
The History of P2P Lending
P2P lending and crowdfunding is in essence not as new as you might think. However, the buzz about those terms started heavily floating in social media investment forum (where I learned about P2P lending), in 2016 based on my experience. However, you might have heard of Kickstarter before? Kickstart was founded back in 2009. Kickstarter is a reward-based crowdfunding platform, meaning you get a product in return for your investment.
However, the first platform which offered an actual investment structure is Zapu founded back in 2005. Zopa is a UK based P2P lending platform and they offer a variety of loans for consumers. Throughout the recession in 2008-2009, Zopa saw a dip in their expected returns but did manage to provide a positive return.
While Zopa was one of the first, and use very conservative interest rates for their investors, they did manage to survive a recession with positive returns. In Zopa’s own post they do not mention how they achieved these returns doing a recession. Therefore, we do not know if they have accumulated profits which could pay for the lacking repayments, or if their borrowers actually repaid their loans.
While it can be used as a risk mitigation for the next recession, we need a lot more platforms to experience a recession before we can actually measure how P2P lending will act over time, including recessions and volatile periods.
P2P Lending and Crowdfunding Companies and Regulation
P2P lending and crowdfunding for an interest rate is quite new and in Europe, the only regulation there is is the anti-money-laundering policies and the accompanying the transfer of funds. Both regulations are based on stopping money laundering and illegal financing. This is also why you have to verify your identity with your passport or drivers license on European P2P lending platforms.
This does not really regulate how the P2P lending platforms are allowed to operate. This means there are no regulations on the transparency of their operations. Many of the European P2P lending platforms does not publicly show their financial statement. Imagine if you could not see the financial statement of a stock you wanted to purchase.
Furthermore, the lack of transparency hiders the investors to know where their money is going. An example is Fastinvest. Fastinvest is a P2P lending platform which does not show any of their loan originators. The only information the investors are given is the country of loan origin.
Throughout the many different platforms, there are many different types of loan types. Looking at the different loan types you can diversify across personal loans, short term loans, agricultural loans, business loans, mortgage loans, car loans, wedding loans, invoice financing, pawnbroking loans and many more.
While a lot of the loan types overlap (e.g. agricultural and business loans, agricultural is a business) there are still many entries of diversification across different loan types. What is important within the loan types is to invest in what you understand – as said by Warren Buffett.
The Downside of P2P Lending Loans
The downside of P2P lending is the risks involved. Especially the historical aspect. Since there is no long term history of the industry it is difficult to weight the risks from a long term perspective.
However, one of the downsides of P2P lending is that if a borrower defaults and there is no buyback guarantee on your loan, your funds are lost. In other investment types such as real estate and the stock market the market can fluctuate, but has always bought a long term positive return. Hence if a property you own decreases 50% in value, you can still rent it out and sell the property, whereas if a loan is defaulted the money is lost.
Another risk is the platforms. Since they are not heavily regulated like banks and credit companies there are many unclear guidelines. This can pose some risks to the investors as they are not informed about the investment made on their behalf (like the Fastinvest example from earlier).
Due to the low transparency of most platforms, the economical state of the platforms are hidden to the public. Some platforms are providing their financial statements, such as Mintos or NEOfinance. This is a way to mitigate the risks of a non-transparent platform. While it is not a requirement that the P2P lending platforms publicize their financial statements, it makes their investment case a lot better.
Should You Invest or Lend within P2P Loans?
I cannot answer this for you. However, as of writing this I am 24 years old and have about 50% of my net worth in P2P lending. I am young, can afford to lose the money (my girlfriend might be mad due to our housing plans) and I am also a risk willing individual.
However, I have made a calculator so you can figure out if you are willing to take the risk based on the returns.
P2P lending’s biggest upside currently is the returns. The average return is around 12% and it is possible to find platforms that can give up to 22% in return.
If you are on edge to invest in P2P lending, you can chose to only a small percent of your total portfolio. If P2P lending should end up being a flop (it won’t) you are still safe overall. You can go to the top of my page and find a platform you which to invest in and read my review. This will allow you to make the right decision right from the start.
If you want a full overview you can go to my P2P lending platforms overview.
Conclusion on P2P Lending Review – Is it Worth It?
P2P lending has its pros and cons. While it is hard to predict the future of an industry, P2P lending looks to be an industry that will stay for the long term. The never-ending growth throughout the world does not seem to take a break. Furthermore, it seems like there is a global miss trust to governments and banks which will be beneficial for P2P lending platforms. If people do not trust banks to manage their money, they will go elsewhere, hence P2P lending wins the long term.
To invest within P2P lending currently, you have to be risk willing. While I have personally never experienced bad debt, I think a recession will change this due to the increase in the P2P lending industry since the last recession, but that is just a hunch.
You can look at my monthly returns from P2P lending here.