Peer-to-peer lending has become the investment of choice for people seeking high-yield returns. The reason is that other investment schemes continue to disappoint, such as savings and bond rates.
In peer-to-peer lending, investors provide no-security loans to borrowers and often get an average yearly return of up to 11% from the investment firm. It seems like the perfect solution to disappointing returns and other investment strategies.
Although, many believe that peer-to-peer lending is risky. The following is everything you need to know prior to creating an account.
How Does Peer-to-Peer Investment Work?
Peer-to-peer is a form of non-bank banking. Comparable to banking, peer-to-peer is about making loans, and the proceeds return to investors via the investment firm. But in peer-to-peer lending, the middleman is cut out, which in traditional banking is the banker. So instead of investing your money via bank in the form of money market funds and certificates of deposit, you will be investing directly to borrowers on the peer-to-peer lending platform.
Borrowers from a peer-to-peer lending site will be filling out an application. They will provide their critical information, including the funds they need and the purpose they need the loan for. There will also be a general evaluation of their credit. This information will be made available to potential investors who can pick which loans they want to invest in.
On a typical peer-to-peer platform, a borrower can borrow up to $35,000 as an unsecured personal loan. The term usually lasts from three years to five years, and the proceeds can be utilized for just about any purpose.
Loans will be priced based on the credit grade, and there are usually at least 12 types of grades. Grades will be based on several factors, which include the following:
- The credit score of the borrower
- Amount of the loan
- Purpose of the loan
- Term of the loan
Contrary to popular notions, a majority of peer-to-peer lending sites do not handle subprime borrowers when it comes to credit. For example, the minimum credit score is typically 600 and up to the mid 600s. Also, they don’t usually lend to people who have had bankruptcies or tax liens.
One of the enormous benefits to investors is that they don’t have to purchase entire loans. Instead, you have the prerogative to purchase what is termed notes. These are a tiny amount of loans in denominations that can be as low as $25. In this kind of strategy, you can spread relatively small amounts of investment capital across numerous notes, mitigating the risk of single defaults completely wiping out your investment.
The platform will handle every administration task of the loan, which include underwriting, distribution of loan proceeds, and collection of monthly payments. These payments are then remitted to the investor on every loan with 1% less as a fee for the platform’s management. Thus, your only responsibility in the entire process is selecting which loans to invest in and then sitting back and collecting the ROI on every loan.
What Are the Rewards of Peer-to-Peer Investment?
Investor interest in the peer-to-peer lending system has grown substantially over the last several years. The reason is the zero interest rates scheme. It is challenging to earn high interests in fixed income properties for anything more than 1% annually. But P2P investing provides a high-yield return as well as other benefits.
- High ROI
A majority of peer-to-peer investors report investment returns of up to 10%. It is hardly a surprise—typical loan rates provided by the platform range between 6% up to 36%. A portfolio of credit grades can effortlessly earn double-digit returns even when you factor in the 1% management fee as well as a reasonable allowance for defaults on loan.
- You Can Build Your Portfolio
On peer-to-peer platforms, you have optimal control over the specific investments compared to most other investment systems. You can select notes based on precise criteria, including loan type, term, and credit score range. You can control the variables around your particular investment. There are even online services that can automate the entire process for you.
- You Can Set Up an IRA
Aside from having a regular investment account, you can also attach your IRA, Roth IRA and even rollover 401(k) account. Thus, you can add optimum returns of peer-to-peer investing to the fixed portion income of your retirement portfolio.
It is crucial to understand how peer-to-peer lending works, along with its advantages. Peer-to-peer lending is an incredible opportunity today which promises higher yields compared to traditional investment vehicles.