There’s risk in peer-to-peer as there is in any investment. The important thing is to understand where the risk lies and the actions you can take to keep this risk as low as possible.
Loans going bad
The most obvious 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 pronounced when the loan is unsecured because there’s nothing you can seize to get at least some of your money back.
By its nature, peer-to-peer suits borrowers who are unable to get funding from banks at lower rates because they’re a higher risk – so however much you trust the platform’s underwriting, it’s rational to assume that some proportions of your loans will go wrong at some point.
Platform Collapsing
A less visible risk is the actual lending platform getting into trouble. The majority of peer-to-peer platforms in Europe are currently operating at a loss: they have backers who are expecting to absorb these losses for a number of years, but it’s entirely possible that a platform could go out of business. Any decent platform will have arrangements in place for if something goes wrong, and in theory someone else will step in to ensure that all loans are wound down in an orderly way. However, in practice that can be a messy process and you can’t guarantee how long it will take to get your money back – if you do get it all back.
Unable to access funds
One of the advantage of peer-to-peer is that your funds are relatively liquid under usual conditions. This is because many platforms have the facility to sell your loan agreements to other investors – something often called a “secondary market” – and usually, there will be plenty of investors standing by willing to buy what you’re selling. However, like all markets, 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 could want their money back all at the same time – just like a run on a bank. 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 to stay safe?
Pick the right p2p lending sites
I see “platform risk” as the biggest danger of peer-to-peer lending: some loans are always going to go bad, but you don’t want to deal with a whole platform running into trouble. Even if a platform doesn’t get into difficulty, there’s still the risk that their loan selection will suffer: they might start saying “yes” to loans where they should say “no”, either because of inadequate staffing or the desire to grow.
The characteristics that make a good p2p lending platform are:
· A good track record: The longer the platform has been successfully running for, the better. Most will also display statistics about their historic defaults (including how much capital was recovered) and their expected loss rate.
· Good liquidity: One source of liquidity is an active secondary market. As I said, a “secondary market” allows you to sell your loans to other investors: in other words, you could lend to someone for a fixed term of 12 months but then sell your share of that loan to another investor two months later to get your money back.
· Good user and customer experience
· Diversify between loans and platforms
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