Peer-To-Peer Lending: The Ultimate Guide

If you’re looking for a flexible way of making a higher return on your money than you’d get in the bank, consider peer-to-peer lending (or P2P lending).

Here’s our quick guide so you don’t have to do hours of research or learn a whole new vocabulary as you do with property or shares. Please understand that these are recommendations only and it is always best to do your own research or speak to one of our advisors for more advice and information.

What Is Peer-To-Peer Lending?

Peer-to-peer lending, at its simplest, is just lending money to another person or business without a bank getting involved, therefore getting a higher rate of return.

However, you still need someone in the middle bringing both sides together and enabling the process, and that's where peer-to-peer platforms step in. Over the last few years, tens of new platforms, each offering something different, have come into the market. If you decide to embark on this avenue it’s sensible to limit the risk by spreading your money across lots of different borrowers – so even if one doesn't repay, you'll only lose a small amount.

Why Bother With Peer-To-Peer?

When measured against three key indicators: safety, liquidity, and interest rates, P2P scores attractively.

Comparatively, if you invest in a bank it is relatively safe and you can access it any time, but the rate of interest is either low or non-existent. Investing in property is also relatively safe as properties tend to hold their value over the long term and you can get a high return if you buy well, but it's illiquid: if you want your money back, it takes time to sell the property.

However, P2P is relatively safe and relatively liquid, while still attracting a relatively high rate of interest. If you split your money across multiple borrowers you have a small risk of major loss, you can quickly sell loans to get your money back, and the interest rate is a lot healthier than you'd get in the bank.

As a property investor you may choose to keep your savings in P2P instead of the bank while saving up for your next purchase – or you could keep your emergency fund there. It’s not guaranteed to be risk-free or liquid, but you might decide that it's worth taking a bit more risk to get a bit more of a return.

Is Peer To Peer Investing Lot Of Work?

You can be as hands-on as you want with P2P investing. Some investors enjoy assessing different lending opportunities and re-investing cash when loans end.

However, if this doesn’t interest you then there are platforms that take all the decision making for individual loans away: you put money into the platform, then they spread it across different loans behind the scenes. There are also platforms that give you a choice: you can either pick individual loans or automatically invest a certain amount into every new loan that comes up until you reach your limit. Essentially, it's as much work as you want it to be.

What Are The Different Types Of Peer-To-Peer Lending?

The three important peer-to-peer lending types are: lending to consumers, lending to businesses and lending against property.

Some platforms will focus on just one and others will offer all three. It’s helpful to have an understanding of how your money could be used – and what the risks of each type are.

  • Consumer Peer-To-Peer Lending

Consumer lending is lending money to another individual for what could be any reason. The reasons are mostly undisclosed, and the platforms decide who to lend to. Importantly these loans are unsecured: there's nothing held as security, so if the borrower defaults there's little likelihood of recovering any of the money.

  • Business Peer-To-Peer Lending

Lending to businesses can be to fund expansion or to help cash flow during a difficult period. Business lending can be secured against property, but at the very least it will usually be personally guaranteed by the directors and secured against the assets of the business too.

  • Property Peer-To-Peer Lending

This type of lending isn’t for people buying houses to live in, nor for investors who want a long-term mortgage. Instead, it tends to be for short-term refurbishment or development projects. It has its risks: there's always the chance of a project going wrong or a development running into trouble for instance. But the advantage is that the loan is protected against the property – so if the borrower defaults, the property can be sold to recover at least some (usually all) of the money owed.

Is Peer-To-Peer Lending Safe?

There's risk in peer-to-peer as there is in any investment, but the important thing is to understand where the risk lies and take precautions to take to keep this risk as low as possible.

  • Platforms Collapsing

It's entirely possible that a platform could go out of business. Any respectable platform will have provisions in place for if something goes wrong. However, in practice that can be a chaotic process and you can't guarantee how long it will take to get your money back – if you do at all.

  • Loans Going Bad

The clearest risk is the borrower being unable or unwilling to pay you back. It can happen with any type of loan, but the risk is more marked when the loan is unsecured because there's nothing you can seize to get at least some of your money back.

Given peer-to-peer suits borrowers who are unable to get funding from banks at lower rates because they're a higher risk, it's rational to assume that some proportions of your loans will go wrong at some point.

  • Unable To Access Funds

Peer-to-peer is all about confidence. If there's a general loss of confidence in the economy or a specific loss of confidence in a particular platform, everyone would want their money back all at the same time. If that happens, there could be lots of loans being sold and none being bought – meaning that you can't get your cash out.

How Can I Stay Safe With Peer-To-Peer Lending?

There's a lot you can do to control that risk if you invest your money intelligently.

Here's we outline the best ways to keep your money safe.

  • Diversify Between Loans

The more loans you can spread your money between, the less affected you'll be by any of them going wrong in particular. Some platforms do this automatically – but if you're picking your own loans, you should split your funds between as many of them as you can.

  • Pick The Right Peer To Peer Lending Sites

Platform risk is one of the biggest dangers of peer-to-peer lending. You need to look out for a good track record, good user and customer experience and good liquidity.

The more established and successful a platform is, the better. Most will also display statistics about their historic defaults and their expected loss rate.

If the website is difficult to use and you can't get help when you need it, it's not a good sign for how the rest of the operation runs. Liquidity (under normal market conditions) is one of the big advantages of peer-to-peer. An active secondary market, which allows you to sell your loans to other investors, is a good source of liquidity.

  • Diversify Between Peer-To-Peer Lending Platforms

If you've split your money between lots of loans and they're all on the same platform, you could still be hugely affected if that platform fails. The safest approach is to diversify between loans and platforms.

In Summary

Peer-to-peer is certainly not without risks but it can be hugely beneficial and work for most people because it offers so much choice.

The key thing is it cuts the banks out. You can also either use it as a hands-off way to get a decent and predictable rate of interest or get really involved and have complete control over how your money gets used.

Some good principles to follow include picking the right platform, lending across a range of platforms, looking for an easy exit and favouring asset-backed lending (where loans are backed by property). If you’d like any advice on any commercial property issues, please contact Prideview and we’d be happy to help.

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