How Safe Is Peer-to-Peer Lending? An Unbiased View About Risks and How to Mitigate Them

How Safe Is Peer-to-Peer Lending? An Unbiased View About Risks and How to Mitigate Them

There is so much debate around how safe is peer-to-peer lending with advocates on both sides. People either say is just crap and shady or that there is nothing to worry about, while others don’t even think about risks when making their first investment, being “brainwashed” by the high returns.

Let me tell you a story about the ones that are totally ignoring risks.

Last year, in November, I was doing my first presentation on peer-to-peer lending (and actually my first presentation in the front of a large audience – pretty scary stuff!). After the presentation, a few from the public approached me to share their experiences with P2P and ask me a few extra questions.

Guess what happened?

Well, it didn’t take me long to figure out that these guys were overly excited about it (nothing wrong with that!) but they also had no clue about risks and how to manage those. They haven’t even considered the fact of losing money. All they cared about is how they can increase their returns even more.

How crazy is that?! I’m telling you, that’s the perfect storm in their lifes.

But you know what?

I can relate to that. I was like them when I started.

Fortunately for me, I realised pretty quickly what I was doing was wrong and that I needed to take control of the situation, to come up with a clear strategy and a set of rules for approaching P2P investments (btw, not for this article, but later on I’m going to share with you the framework I’m using for safe peer-to-peer lending investments).

Anyway, enough with the small talk, let’s get to the point.

I won’t try to provide you an answer for how safe is to invest your hard earned money in peer-to-peer lending, that’s up to you to decide. What I will do is to provide you all the information you need to decide on your own.

In general, whenever you decide to invest in something new, you need to assess the risks and only if you feel comfortable you should move forward.

If wasn’t clear yet, investment in peer-to-peer lending, although very profitable, it also comes with risks. Let’s see what are the those exactly and what we can do to mitigate them.

Money drag

It represents the risk of not having your money invested all the time in loans. Due to various reasons you can end up with money sitting in the P2P platform for days and days and not producing other money. The result will be that our overall return will drop.

This usually happens when you use aggressive Auto Invest strategies which reduces the chances of finding loans that will match all your criteria, so be careful with this. Part of this guide I will teach you how to mitigate, if not completely eliminate this risk when we will discuss about investment strategies.

One more thing to mention here, the return of your portfolio displayed by platforms doesn’t take into consideration money who aren’t invested, so it’s easy to get tricked and think you’re doing good but in reality you’re not. My recommendation is to always calculate your own return using the XIRR method, so you know how you’re really doing.

Loans with delayed or no payments

In this case loans will most probably default, but this is nothing to be scared about. Is normal for something like this to happen for a certain percentage of loans, and we should accept it, but at the same time we also need to take the right steps to protect ourselves as much as possible.

Fortunately enough most of the platforms are offering loans that come with the Buyback Guarantee protection. This means that the loan originator (credit company) who issued the loan will guarantee you will get your money back in case of loan default. Usually you will receive the principal you originally invested, and some loan originators will also offer the accrued interest.

My advice here: do not invest in loans that do not have the Buyback Guarantee protection activated, or some other way of ensuring you get your money back in case of loan default.

There is still a catch here, with the potential of slightly lowering your returns, and this is the Grace Period.

A loan enters the grace period if a payment is missed and only at the end of this period the loan is marked as defaulted. The period was designed to take into account delays due to holidays or special events and usually is between 3 and 10 days. This is important to understand as most of the time you will not get interest for this period.

The impact of the grace period is more visible for short loans (up to 30 days), so when you pick such loans see if you can get only those with the shortest period.

Bankruptcy of the loan originator

It’s probably the most important risk, and thus you need to make sure you’re making the right choices. If the loan originator goes bust then there is a high risk to lose all your money invested in loans originated from that credit company. Not even the buyback guarantee will help you here, as the company will simply not have the money to honour it.

It happened in the past, and probably the most high profile one was the bankruptcy of Eurocent from Mintos. Now things are in the usual bankruptcy procedures, and Mintos is trying to get the money back for investors, but it’s a process that will take time.

One way to reduce this risk, it’s by taking a closer look to loan originators, understanding how solid they are. If the platform offers ratings for them, make sure to not ignore them. And let’s not forget about diversification on as many originators as possible, to make sure that if one really gets in trouble it will not be a major hit for our portfolio.

Bankruptcy of the platform

With the risk to lose all your money you invested. Here you will have to do a little bit of research about the platform prior to investing. We will try to understand if it has reached profitability, how good support is, who are the people behind it and so on.

I suggest to join Facebook groups or read established bloggers on the subject, as that will provide you important insights that otherwise you won’t be able to find out.

All of these put together will provide us a better picture and can potentially save us money in the future.

The best way to protect against this risk is to diversify our investments across multiple platforms, targeting different loan types from different countries and so on.

Over-diversification

Yeah, we should diversify across multiple platforms, but be careful to not go overboard with this. If you go with too many of them it will be very hard to manage them and in the end you’re going to lose control, and that would be very bad and probably in a way or other will have negative consequences.

But how many is enough?

It depends on the ability and time of everyone, so there is no magic number here. For me this is around 5 to 7, and anything above that number I feel that will require me extra effort and not sure is worth it.

Yourself

As we are people and people tend to be emotionally driven, we need to see ourselves as a risk, not just for peer-to-peer lending, but for any type of investments.

Therefor, don’t get overly excited, and when you do, think twice when you want to put your money into something new. Start with a plan and stick to it. Most of the time that’s all you need to stay safe.

My final advice

Probably the best way to protect yourself is to be careful about the percentage you allocate to peer-to-peer lending, my opinion being that you shouldn’t invest more than 5% or 10% of your total portfolio. 15% or 20% is not bad either, but you really need to make sure this is an informed and assumed decision, and not just something random.

Yeah, maybe you won’t get the maximum out of it, but yet again, things can change rapidly, and what works now, may not work in the future.

As we can’t predict the future, the best is to be prepared no matter what. Remember, rule #1 in investing is to not lose money, so maximising returns for your overall portfolio shouldn’t be a priority.

Peer-to-peer lending is as safe as you’re making it to be. There are money to be made, and with proper risk management you’ll be fine.

What do you think? Is P2P lending worth the risk?

Feel free to use the comments section below to share your opinion on peer-to-peer lending risks, or even send me a personal message.

Do you think peer-to-peer lending is safe?

If you’re not investing already, are you considering doing so? Or you think this is just overrated and too much risks, with better opportunities out-there?

Will you invest all your savings in peer-to-peer lending being amazed by those juicy returns?

What ever you feel about it, I would love to hear it.

Until next time,
Marius

P.S. In the next post from the guide we will talk about transferring funds with zero costs into the platforms so that you can get started and earn money. We are going to be very practical about it and show you step by step how to send money to Mintos. No worries, same method will apply for any other platform.

Disclaimer: This is a personal blog, containing our opinions and views, and nothing you read here can be used as investment advice or recommendation. You should also know that some of the links in this post may be affiliate links, meaning, at no cost to you, I may earn a commission. Read the full disclaimer here.

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