What Is Peer-to-Peer Lending?

What Is Peer-to-Peer Lending?

This is the first post of the best step-by-step guide for peer-to-peer lending investments in Europe.

If you already have good knowledge of what P2P lending is, then it will save you time skipping this post. Wait for the next one though, as I am going to start talking about platforms, and share all the goodies. Otherwise, carry on the reading.

I started to invest in P2P lending from September 2017, and it has been a fun ride since then. I had successes and also failures, I’ve made good money, but I have also lost some of them (not a lot, but a loss is a loss).

In any case, my goal will be to share my experience with you, so you don’t have to make the same mistakes as I did, and at the same time meet wonderful people with the same passion, that can teach me a thing or two, so that in the end we all grow together.

What is Peer-to-Peer lending?

As you probably guessed, when we talk about peer-to-peer lending, we talk about borrowing money from the people to the people, giving us, the individual investors, a new way of multiplying our money. Love that!

I am pretty sure everyone at some point has borrowed money to a friend, a family member, or someone you trust. Most of the time you did that without any interest, because you simply wanted to help.

Well, peer-to-peer lending is very similar to that, but you do get interest, and you don’t borrow to just one person, but to hundreds.

You will do that through online platforms, that will act as an intermediate between you, the investor, who has the money, and individuals or even businesses who need them.

Once you invest the money in a loan, that will generate a monthly profit for you (interest), and by the end of the loan you will get your full money back (principal).

To make another analogy to our daily lives, peer-to-peer lending is very similar to how banks function, but in our case, the online platforms are playing the bank’s role and we, the individual investors, play the role of people who deposits money in banks. The good thing is that we have full control to whom we lend those money to, versus banks, where you have no idea how your money are being used, but the bad thing is that it also comes with more risk.

In fact, this new way of lending money has appeared from the frustration of working with banks, the process of applying for a loan being very complicated, and takes a lot of time. On the other side, the depositors aren’t getting a bang for their money, at least in the last few years, the interest being very low.

Although it’s a new industry, it has a future, as is solving a real problem for people, and if you think about it, it’s a win-win situation for everyone. I am not saying it will replace banking, but it will be another way to loan money without the usual hassle to deal with banks.

See below a visual representation of how this works:

As an investor you will be able to choose between a wide variety of loans, the most common ones being for personal needs or car financing. At the same time, you will be able to find loans for businesses and real estate projects, which I appreciate the most.

The duration of the loans can be from a few days to years, so you can choose what you want best. More than that, you can invest in loans issued in different countries, allowing you to create a really diversified P2P portfolio.

What I am trying to say here is that you can be very specific on how to invest your money, targeting only those loans that suits your strategy. Awesome!

Why choose Peer-to-Peer Lending as a way to invest your money?

That’s a very good question, and I’m sure each and one of us has their own favourite way of multiplying their money.

It’s very possible that for some of you this way of investing may seem a little bit too risky, or simply you don’t like it, or why not, you think there are better opportunities out there.

And that’s alright, thankfully we all are very different, and have different views on how to run our investments and ultimately our lives.

However, I’m sure that are many who are really going to like it and enjoy this new way of making money.

Anyway, here are the main reasons why I invest in P2P lending:

  • Solid net returns: you can get anything between 10% and 15% or even more, based on the risk you’re willing to take. For sure it’s much better that keeping your money into a savings account where you will get at best 1-2%.
  • It won’t require a lot of your time, at most one or two hours, now and then. With majority of existing peer-to-peer platforms the process of investing in loans can be fully automated, and you just need to check the settings from time to time.
  • Many platforms offers protection against defaulted loans, so you will be safe when a loan can’t be repaid. This protection is called Buyback Guarantee, and I don’t recommend investing in loans that don’t have it. We will learn much more about how this works in the upcoming posts.
  • It’s an easy way to diversify your overall investment portfolio, a small part of it could be allocated for P2P lending.

So far so good, but wait…, let’s talk about risks

We are talking about lending, you are actually going to borrow money to someone. You have to understand there are risks associated with this, which can be mitigated if you know what you are doing.  

The biggest risk is for the loan to default, so won’t be returned. It happens for banks as well, for example, in case of people who borrowed to purchase a home and can’t repay the money back. It’s normal for this to happen, and we should accept this, but at the same time we should see what can we do to protect ourselves as much as possible.

The first thing that we need to do when we pick our loans is to be sure that we choose the ones that have Buyback Guarantee, most platforms offering that. Choosing any other platform that don’t offer this is just an added unnecessary risk.

As a side, unfortunately, I had to learn this the hard way, losing money and ending up with a negative return. Later on, I will write a blog post about this as well, believing you can learn much more from a negative experience compared to a positive one.

Back on topic, in the next posts we will learn more how this mechanism works, but for now all you need to know is that you will recover all of your money, and in some cases with accrued interest, even if the loan defaulted. In any case, is extremely important to purchase loans that have this protection enabled.

A second thing we can do to lower the risks is to diversify on all levels: invest in multiple platforms, not just one, choose different loan types, and also make sure you invest in loans issued by different loans originators from different countries.

Another important thing to mention is related to the amount you are going to invest in a single loan, and the rule of thumb is to always choose the minimum possible amount (for example, on Mintos, one of the platforms, the minimum is 10 EUR). We don’t want to expose ourselves to a single loan more than we have to.

One last important risk, and most of the time overlooked and downplayed is the risk of investing too much money in P2P lending.

It may be of a surprise for you that I mention this, but this is indeed a tricky one, mainly due to high returns we can achieve. When you see how easily you can get returns between 10% and 15% and sometimes even towards 20%, you are inclined to invest more money.

Please don’t do that.

In my early days, while I was over excited about P2P lending, I ended up pouring more money into it than I should have. I knew this was wrong, but I simply couldn’t resist it (yeah, investments shouldn’t be emotional).

Since then, I have become much more disciplined, and resolved the problem, downsizing my initial investment.

I also took steps to rethink my overall investment portfolio, considering P2P as an alternative investment (pretty much like crypto). This means that I am now targeting anything between 5% or 10% allocation over the entire portfolio (stocks, bonds, etc..).

I am not there yet, but slowly moving towards that goal. In any case, just remember that what now goes well, it can also go bad later, and as we can’t predict the future, best thing to do is to be prepared for all scenarios.

We will always have risks for any type of investment, not just for P2P lending. We can’t eliminate them completely, but with the right approach, and a plan in place there are money to be made.

That’s it for now, but remember, this is just the first post from a guide that will teach you how to make money from peer-to-peer lending. So don’t forget to check our website from time to time for more goodies!

What do you think?

Feel free to use the comments section below to share your opinion on peer-to-peer lending. If you choose so you can even send me a personal message.

What do you think about it, are you already investing, or you’re just starting and trying to learn more?

Is this new way of investing absolute crap (too much risk)?

Or is the perfect way of making money for the new generations, due to simplicity and high 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 dive more into the risks of investing in peer-to-peer lending, and how we can mitigate those so that you and your money can stay safe.

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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