7 Tips For Becoming A P2P Lender

By Ronald Kimmons. May 7th 2016

For centuries, people have borrowed and lent money in three basic ways. First, they have done so through personal relationships. Such borrowing and lending is usually done as a personal favor instead of as a business venture, and it is generally considered bad form to charge interest – or even demand payment. Second, banks have stood as buffers between borrowers and lenders, taking most of the interest profits and conveying a tiny amount to those with the savings accounts from which they have their loans. Third, investors have bought bonds issued by corporations. This paradigm of lending has resulted in a long-standing dependence on financial institutions as facilitators – making it difficult for independent investors to function as lenders to individuals and small companies. However, with the advent of various Internet-based technologies, companies like Prosper and LendingClub are giving independent investors the tools they need to become P2P lenders and compete directly with the banks. This presents a significant opportunity for independent investors. However, it also presents them with risks. If you intend to become a P2P lender, to maximize your earnings, bear the following tips in mind.

Do Not Enable Irresponsible Borrowing

In some cases, a potential borrower may say that he or she is only looking for a loan to “supplement” a regular income stream. If this is the case, watch out: that borrower is probably not being financially responsible. If someone cannot meet current financial obligations, getting a loan may help for one month, but it will result in even heavier financial obligations in the future. As a lender, you do not want to lend to someone so financially irresponsible, as such loans tend to result in default.

Look For Refinancing Opportunities

The majority of loans made on LendingClub, Prosper, and other such platforms are refinancing loans. Such loans come as a result of consumers realizing that they can save money by paying off existing debts – such as credit card debt – with a P2P loan that carries a lower interest rate. Refinancing loans tend to be safer investments than most other loans because those seeking them are often meeting their current financial obligations: they simply want to minimize those obligations.

Be Wary Of Business Loans

Some of the prospective borrowers on P2P lending sites are entrepreneurs and business owners who need quick cash. Some of these opportunities are safe, but others are quite risky – especially in the case of startups. Remember: Most startups fail. Before putting your money toward a business loan, make sure that the business has a proven track record. One good thing about lending to businesses is that, since being in business almost always means having an Internet presence, it is usually easier to verify business legitimacy than to verify an individual person’s legitimacy. Look at the company Web site and any financial documents that the prospective borrower has submitted. In most cases, lending to companies that have not shown at least two years of stability can be risky.

Take Calculated Risks

All loans constitute risk. The P2P lending services accommodate for this by offering a sliding scale of interest rates based on credit scores. If you loan only to those with best possible credit scores, you are likely to protect your principal, but you will not profit from high interest rates. If you only make high-interest loans, you will probably see a high rate of default. Investors who enjoy the highest returns on their P2P loan investments are those who make specific high-interest loans after careful consideration. This is because savvy investors can differentiate between high-interest loans with a high probability of default and those with a low probability of default.

Choose A Reliable P2P Lending Service

With the success of Prosper and LendingClub, various other companies with similar business models are popping up. However, not all of these are legitimate or stable. If the P2P lending company servicing your loan goes bust, there is no telling whether or not you will ever get your money back. (You probably will not.) For this reason, it is best to stick with the tried-and-true industry leaders. Even if a competitor promises a better fee structure, remember that you get what you pay for. (For investors in the UK, Zopa and Funding Circle are two stable options.)

Diversify

One of the main advantages of the P2P lending structure is that it allows lenders to minimize their risk by spreading their investments over an entire collection of loans. Do not log in to a P2P lending service and immediately drop thousands of dollars on one loan. Spread out your funds among multiple loan opportunities in such a way that a default would not destroy you financially. You may also consider diversifying loan grades: it is often good to make both “safe” loans to borrowers with good credit scores and “risky” loans (for high interest) to borrowers with less-than-ideal credit scores.

Think And Learn

As with any other type of investment, P2P lending requires thought. Weigh the risks and the profit opportunities, and consider your ability to absorb losses. Do not overextend yourself, but take advantage of the best opportunities as they appear. Watch the performance of your loans, and adapt your practices accordingly. If you make mistakes, learn from them.

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