P2P lending

What is peer to peer lending?

Peer to peer lending is a way of funding needs of an individual who in return will pay back along with an interest. Unlike a personal loan the lender is a common man.

Peer to peer platforms bring unknown lenders and borrowers together to make loans. These platforms function to keep the transactions simple and trustworthy. Apart from the returns a caveat lender has to take into account the risks of lending to an unknown by only trusting the data provided by the borrower himself and professional conduct of the platform. These are basically an unsecured loan provided by the platform with decent returns. A risk averse investor who accepts the risk unless fairly compensated by returns should never opt this route for diversification.

Compiled below are some risks involved in investing through peer to peer platforms and also how to avoid them.

Insufficient diversification

Peer to peer lending acts as a diversification to your overall portfolio. Lending through various platforms is one kind of diversification, which eliminates the platform risk, the risk of the platforms going bust. Most platforms don’t allow more than a certain amount to be lent to a single person, in case of any platform that makes lending flexible i.e., without lending restrictions be sure to split the money across types of loans. This eliminates the risk of defaulting.

How to avoid?

  • Lend smaller amount to a large crowd.
  • Opt to invest in different p2p platforms (list given below).

Not holding for a reasonable time

Platforms advice lenders to stay invested for more than 2 years, the direct implication is to retain customers. It’s actually a legit way of getting above average returns because in a year or less than that, some borrowers default which might decrease the overall return for that year. Holding on to the losses for short to mid term will diminish all those losses made in the previous years. If borrowers default continuously, the returns will still be meagre this kind of risk becomes inevitable reflects weaker recollection policy and inefficient mediation.

How to avoid?

  • Improve financial literacy. Emotional intelligence plays a major role in investing and managing money.
  • Look for track record and NPA of the platform.

High risk, High returns, No free lunches.

Testing the waters with one foot:

Pupils dilate people hear double digit returns and forget about the risk comes with it. Lack of financial literacy keeps people closer to returns and away from the uncertainties. Being new to the platform and peer to peer lending, invest in bits to get used to the platform and wait for repayments. The criteria for admitting the borrowers to the platform is almost unknown. Getting to know the platform and gaining trust should be the first step in investing with p2p platforms.

How to avoid?

  • Allocate least part of the portfolio and wait for the repayments.

Reason for borrowing:

Getting to know the reason for borrowing plays a crucial role, people who borrow in good faith spend on serious commitments implying, high possibility that he/she repays. Shopping, salary overdraft and other lavish spending shouldn’t be funded and these kinds of loans made are almost to be forgotten. One who is cautious about lending will not spend them irrationally and the odds of repayment are relatively high. Platforms typically have recollection policies, this measure is to be on the safer side.

How to avoid?

  • Lend for reasonable spendings.

Algo reinvestment:

To prevent keeping funds idle in the account, platforms transformed to automatic reinvestment with the help of algorithms. Maybe this is good for higher Y-o-Y yields, but the loans made can be of lesser credit quality than the lender initially makes. The algorithms concentrate only on funding open loans which enhances the service and not a better option to fund credible borrowers.

How to avoid?

  • If available, Tick options that prevent automated reinvestment.
  • Regularly look for idle funds lying in your account and lend them manually.

Platforms going bust:

When platforms go bust the lenders may not be able to get their money back or the principal repayment gets delayed. This can be avoided by lending through multiple platforms (2-3). In India, p2p platforms should be registered with RBI. Without knowing the management upheaval lending using third party applications is dangerous.

How to avoid?

Protection from the p2p platform:

  • In some cases the management insists the borrower to have or avail an insurance to safeguard both the lender and the borrower himself.
  • Credit score of every individual will/should be provided by the platform.
  • Purpose of lending weighs more while accessing the loan.
  • Income information, loans outstanding and monthly dues of the borrower will/should be available.

Independent opinion:

Being in India, Lenden Club has given better returns and qualifies every above mentioned points. Personally, have been using this for a year and satisfied with their service. Click here to start lending