How Peer to Peer Lending Works
A relatively new money lending phenomenon has been growing over the past few years. P2P, or peer to peer lending, is a great resource for those wanting to borrow money at competitive rates or for those wanting to invest their money for a decent rate of return. With the economic climate so bleak lately, many of you might be wondering where to invest your money for a decent rate of return. If so, P2P lending is definitely worth consideration. It isn’t risk-free, nothing is, but if you carefully choose borrowers with good credit scores then it is safe to say you can easily expect a 7 to 9 percent return, which beats recent stock market performance and definitely surpasses CD and bond rates. I’ve made a hefty 18% return from my lending portfolio over the past 2 years. However, I do lend to less creditworthy borrowers, which allows me to demand higher interest rates.
How Peer Lending Works
The peer to peer lending process basically involves ordinary people loaning money to each other, replacing the traditional method of asking a bank or consumer lending company for money. It’s also known as micro-lending because any given loan is funded by many people lending small amounts of money. For example: if a borrower needs a loan for $5,000 then he/she would submit a loan request. Then, many different lenders offer small amounts (around $50 each) until the funding reaches the $5,000 level, so you end up with 100 different lenders and one borrower. The lending works through a bidding process, whereby each lender offers money at a certain interest rate. This is great for the borrower because each lender will try to underbid the other lenders, thus lowering the interest rate. As a lender it is also an excellent arrangement because lending small amounts of money spreads your risk in case of a default on the loan. So, if you have $2,000 in capital available to lend you loan it to, say, 40 different borrowers instead of 1 or 2 borrowers. This way, if a borrower defaults on a loan you are only out $50 instead of $1,000 or $2,000.
Where to invest in Peer to Peer Lending
There are a number of these P2P marketplaces that you can choose from. I’ve used Prosper with great success. However, they recently entered into a registration process with the SEC in order to offer lenders the opportunity to sell bundled loans. This process doesn’t allow Prosper to accept any lenders at the moment, but I’ll update when they are once again accepting new accounts. Lending Club is similar to Prosper, but is less risky for lenders because they only allow borrowers who have a credit score of above 660. Lending Club has a good FAQ page and a free Javelin report that analyzes lender performance since inception for those interested in learning more. It’s also a good idea to sign up using their simple 4 step process, which asks for your pertinent details and bank account information. You don’t have to transfer any money into your new account though. You can cancel immediately afterward if you want, but signing up allows you access to their site and loan platform, where you can get a feel for how things work.
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