P2P Lending: An Assessment of the Risks and Opportunities

Peer-to-peer lending or P2P is the method of lending cash to people who are not related to the lender. This kind of lending usually takes place online and does not involve any financial institution.

There are several P2P lending websites and they use various credit checking tools to determine the borrower's eligibility for the loan.

What risks are involved?

P2P loans are 'unsecured personal loans' made to individuals who have not put up collateral.  Remember that the lender will not receive any government protection for his/her investments. However, they can reduce their risk by selecting the 'right' borrowers and diversifying their investment among different borrowers.

Aren't they risky?

Yes, these loans carry a high amount of risk as they are not secured. However, if you take a look at the default rates of these loans on P2P websites you can see that most borrowers repay.

Borrowers are expected to have a decent credit score to qualify for these loans. The interest rates usually depend on the borrower's credit history. Higher risk borrowers will have to pay higher interest rates. Borrowers who are considered low risk will be eligible for low interest rates.

These kinds of lending companies are now being watched by the Securities and Exchange Commission and many of them have obtained SEC's full approval.

Transparency

P2P websites conduct their business in a transparent way. The investor will have access to complete information on each loan prior to investing their money. It is true that these loans are unsecured, but the lender can reduce their risk by lending small amounts to many different borrowers. Credit card loans, too, are unsecured loans, but that hasn’t stopped banks from offering them. Just like credit card loans, P2P loans, too, are reported to credit agencies. So a borrower who fails to repay the loan will damage his/her credit score.

Who operates these loans?

P2P lending is a for profit online business. It generates income by collecting fees from borrowers on the funded loans. The website may also collect a fee from the investor. These websites are fully automated, so they don’t have to employee many people. This reduces their operating expenses. Consequently, they can pass some of these benefits on to the borrower by offering lower interest rates. While at the same time, they help lenders earn higher interest rates

Right now, P2P is a fast growing investment opportunity. Even investment bankers from traditional lending institutions are joining these P2P websites as lenders, investors and board members. This clearly indicates that the new lending platform is gaining credibility.

The bottom line

Even traditional banks find peer-to-peer lending attractive. That is a good reason for an investor to consider this lending platform. You can reduce your risk by investing small amounts. Also, instead of lending the whole amount to one borrower, you can divide the money into smaller sums and lend them to different borrowers. This reduces your risk because all of your borrowers are unlikely to default.

Traditional bank deposits offer lower interest rates and that is the reason investors are turning to alternative investment opportunities. While P2P lending has its own risks, the returns are good enough to attract many investors.

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