The popularity of P2P lending as an alternative to traditional loans for both individuals and businesses is on the rise. These days, internet-based platforms such as Mintos and Lendix, match lenders with borrowers hence, enhancing the efficiency of capital allocation. In 2015, the global Peer to Peer market was valued at $26 billion, and the market is projected to reach $460 billion by 2022.
As these online platforms grow, investors are promised higher returns. Similarly, the borrowers have a more accessible source of funding that comes with lower interest rates.
However, just like any investment platform, there are several risks involved with P2P lending. Below are ways on how as an investor you can stay safe when investing in peer to peer lending market.
1. Diversify Your Peer To Peer Investment
Diversification can be categorised into the following scenarios:
Additionally, if you want to invest in two borrowers who have similar creditworthiness, you should ensure those borrowers operate in different industries. By doing so, you will reduce the risk that may occur in case one sector is affected by political changes or a catastrophe.
2. Do Your Research
Each P2P website is required to verify documents and information submitted by their borrowers. The platforms make this information available to investors through their websites.
Generally, lending operators will carry out a credit assessment for all their borrowers. Nonetheless, you should not rely on this assessment alone. Carry out your research in terms of age of the borrower, their historical financial information, their repayment history, and the loan tenure.
3. Monitor Your Investments To Mitigate The Risk Of Cash Drag
Cash drag is the reduction in ROI (Return On Investment) due to funds sitting idle in accounts such as holding accounts. The PDS of most lending platforms clearly states that lenders will not receive any interest for funds in such accounts.
Therefore, you can mitigate this risk by monitoring your investment and having various borrowers and platforms that you can move money to in order to avoid the effect of cash drag.
4. Understand The Lending Platform Thoroughly
Each business has its risks, and when you are investing in any lending website, you are investing in that platform. To reduce platform risks, you should understand the stability of that website by looking at factors such as its management, its length in business and its past performance.
Furthermore, you can ask how the platform works and the potential risks involved before lending out money on it. Additionally, you should not hesitate to ask the peer-to-peer company about its defaults, recovery process, the overall volume, and the possible returns.
5. Lend Across Different Time Periods To Improve Your Liquidity
Even after lending, sometime, you might need urgent cash. Most platforms will not allow you to access the money before the set time. And the websites that will agree to give you early access are likely to charge a hefty fee.
To avoid such a scenario, you can separate your emergency funds from that of investing. For instance, you can save up cash that can cater for your living expenses for one year.
Moreover, you can spread your investment across different periods. For example, you can lend a short term loan that should be repaid within a month or have a long term loan that will be due in five years.
6. Lend At Various Interest Rates
Generally, loans with higher risks have a higher interest rate. Even though you are likely to get high returns from these type of loans, you should be cautious of the risks involved.
For instance, you may find out that the loans with high rates have more incidences of bad debts, write-offs or even loan defaults.
To avoid this, blend your lending by issuing loans across various interest rates. By doing so, your P2P portfolio will have a balance of high risk and low-risk borrowers.
Peer to peer lending is one of the most revolutionary yet disruptive financial innovations in the 21stcentury. It does guarantee a higher rate of return only if as an investor you play your part accordingly and spread your risks. Before you invest, do conduct your research and check out the available securities and fees; use the tools available for you and go for the best deals in the market.