What Is P2P Lending?

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What is P2P lending? To many people this is a new concept even though it has been around in many years. P2P lending is a way individuals or businesses can gets loans from other individuals. P2P lending is therefore removing the need for banks. Websites, known as P2P lending platforms, act as middlemen providing loans to individuals and businesses from the investors money. P2P lending platform is advocated to have a lower overhead cost and providing their services cheaper than the bank alternatives. This makes the investor eligible for higher returns than the traditional savings account, even though they basically works the same way.

Another easy way to interpret P2P lending from traditional banking is that P2P lending is small sums from a lot of sources and traditional banking is large sums from one or a few sources.

P2P lending is also known under the terms crowdlending and crowdfunding.

One of the biggest advantages of P2P lending is the instant compounding effect of your investment. You can use the calculator to calculate the returns if you get started.

How Does P2P Lending Work?

Traditionally you use a bank to get a loan. When banks approve loans the money used to fund the loans are deposits from other customers. This means that the banks earn interest on your bank accounts, where you only get sub-1% interest. However, P2P lending lets investors fund loans directly to the borrowers for a high interest rate.

P2P lending is typically done through investment platforms such as Mintos, Grupeer, Swaper and any other platforms. These platforms act as a intermediate between borrowers or loan originators and the investors. The loan originators and the platforms are advocated to have lower costs than banks. This will make both the investor and the borrower benefit from P2P lending. Furthermore, the investor has the ability to choose which loans they want to invest in.

The typical picture you will be presented with, will be having the investors on one side and borrowers on the opposite side with the platform in the middle. Mintos P2P lending platform present it in the following picture:

How does Mintos work?
How does Mintos work?

While Mintos has one way of showing their version of how P2P lending works, the European Commission has another way of visualizing it. However, it tells the same story and the meaning of the pictures are the same.

Crowdfunding/Crowdsourcing/P2P-Lending - How it works
Crowdfunding/Crowdsourcing/P2P-Lending – How it works (Source: European Commission)

You can also read my in-depth go-through of why the European Commission view P2P lending as a big funding opportunity for small businesses.

P2P Lending Advantages and Disadvantages

There is some clear advantages and disadvantages of using P2P lending, both as an investor and as a borrower.

Advantages

  • Higher returns than traditional investment types
  • Typically fee free investing
  • High diversification between industries and amount of loans
  • More accessible way of funding

Disadvantages

  • The current legislation is vague/non-existing
  • Credit risk

The advantages more or less speaks for themselves. You get a higher return than if you go for stocks, real estate etc. Furthermore, the P2P lending platforms typically offers free investing for investors. However, the borrowers pay the fee when acquiring a loan, just like when acquiring a loan through the bank. With the low fees investors are also able to heavy diversify across multiple loans. The platforms offers loans within development projects, mortgage loans, personal loans, business loans and much more. If the same diversification where to be done with stocks the fees would have eating away a lot of profits.

Unfortunately, there is disadvantages of the P2P lending. One is that the current legislation is very limited to either the anti-laundering policy or a total ban from authorities. E.g. as of writing this post the UK has banned P2P lending due to the investors risk. Furthermore, there is a chance that the borrower will default and your investment is lost. However, as a risk mitigation some platforms offers buyback guarantees. These buyback guarantees are typically offered through the loan originators. Therefore, if a loan originator goes bankrupt the buyback guarantee will be worth nothing, and your funds will be lost.

Is P2P Lending Safe?

There is always risks when investing. Particularly people are fearful of P2P lending because it is a new type of investing compared to the traditional stock picking, index funds and real estate. However, P2P lending is only as risky as you make it. The P2P lending platforms has done a lot of mitigation to secure the investors. The P2P lending platforms are not interested in bad borrowers. If they get poor loan originators or lend to the wrong people, the platforms are not making any money either.

There is 7 risks to consider when/before investing in P2P lending. It is not hard to mitigate and it is fairly easy to follow:

  1. Platform diversity
  2. Loan originators/borrower
  3. Understand the platforms
  4. Financial state of the platforms
  5. Regulation and legislation
  6. Haven’t experienced a recession
  7. Psychological risk (You are a risk)

One risk that is easy to relate to is diversification of investments. You might have heard the phrase “Never but all your eggs in one basket”. This is true no matter what you invest in. When diversifying it is important diversify not only across loans but also on different platforms.

Closely related to the platform diversity is the loan originators. While it is important to diversity across loan originators it is also important to evaluate loan originators. The loan originators might have been assessed by the P2P lending platform. A platform known for doing this is Mintos. However, some platforms are acting as loan originators as well. While a platform like Mintos is intermediate from borrowers to investors, platforms like Envestio is lending to borrowers themselves through their platform instead of using loan originators.

The different platforms in Europe all have diverse strategies and ways of working. Therefore, it is important that you understand the platforms you are investing with. If you have invested in loans with buyback guarantee on e.g. Mintos or Grupeer, you will get your funds back if the borrower defaults on the loan. However, if the borrowers defaults on a platform like Envestio, you will have to accept the full loss of your funds.

A very underestimated step of risk assessments is the financial state of the platforms. If a platform does bankrupt you can be exposed to financial losses as well. Again, it is important to understand how the platforms are put together. Using Mintos as an example: the loan originators are liable for the loans even if Mintos goes bust. Mintos will only act as an intermediate from the loan originators to the investors.

Knowing the legislation will help you a great deal. For example, the UK suddenly banned P2P lending for investors due to the risk they are exposed to through the P2P lending. The UK authorities would like to develop some legislation to regulate the P2P lending industry. The UK authorities have have discovered some risks towards the investors, and to protect the UK investors they have banned P2P lending until further notice. If your region were to do such regulations, you should act and comply with the regulation.

The platforms LendingClub and Prosper are the only platforms old enough to have been through a recession. They where both in the 2008 recession. New platforms are emerging all the time, while the older platforms are expanding. Therefore, the P2P lending industry could be inflating and collapse in the next recession.

The last risk there is, is you. If you get greedy or fearful you are exposed to the same risks as when investing in stocks. Lets take a example of both. If you are fearful, you are investing in loans which are expected to be very safe. However, these loans are also the once which provides the low returns. The opposite is true if you are greedy and go for the highest possible returns. This also bares the highest amount of risks.

You can read a more in-depth of P2P lending risks and ways to mitigate the risks in my 7 risks of P2P lending article.

If you are already a registered investor on Mintos you can read my post on how to achieve high returns while having a low risk on my Mintos loan originator post.

Best P2P Lending Platforms

The best P2P lending platform for you depends on the risks you are willing to take. If you are high risk, high reward you should invest on platforms such as Envestio or Bulkestate. You can read my thorough review of both Envestio and Bulkestate on my Envestio review article and Bulkestate review article. If you are looking for a safer investment risk, you should look at platforms like Grupeer and Mintos. You can read my thorough review of both Mintos and Grupeer on my Mintos review post and Grupeer review post.

There is several platforms which is to consider when choosing the right platform(s) to start investing on. Personally Mintos is a “must have” in everyone’s portfolio. Mintos is a platform with over 400.000 active loans on the primary market. Furthermore, 95% of their loans are with buyback guarantee. Despite the opportunity for high diversification, Mintos offers an average return of around 12% per. You can sign up via my link and receive an additional 1% interest on your first 90 days of investing. You can sign up here and receive the bonus.

If you are willing to take on more risk or just want higher returns, you should consider signing up on either Grupeer or Envestio. While Grupeer offers returns of up to 15%, they also provide a buyback guarantee. However, if you are looking for returns up to 22% you can sign up at Envestio. If you sign up on Envestio you can get an 0,5% extra return on all your investments for 270 days. Furthermore, you get a signup bonus of €5. To receive this awesome bonus you must sign up through my link to Envestio.

Conclusion

Through this post i have highlighted some of the most essential topics related to P2P lending:

  • What is P2P lending?
  • How does P2P lending works?
  • P2P lending advantages disadvantages
  • Is P2P lending safe?
  • Best P2P lending platforms

P2P lending is a way for small businesses and individuals to lend money at a cheaper rate than banks can offer. Furthermore, there are P2P lending platforms in place which works as an intermediate for the borrower and the investor. The P2P lending principle is followed with many benefits. However, there is also a few disadvantages. For the investor, there is typically no costs associated with investing and the returns is considered better than other investment types.

The P2P lending is for now considered a risky investment. However, there is ways to mitigate the risk.

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