This is a page that will be continuously improved based on the best available industry information. The initial information source for this post was a White Paper published by Grupeer in the fall of 2018. I copied part of the information and add my personal notes to it.
No information contained on this page constitutes tax, legal, insurance or investment advice. I hope this information helps you decide if including P2P lending is a good strategy for your savings & investment financial portfolio!
Why include P2P lending to your investment portfolio?
Do you want to be the boss of your own financial situation and make money by being an investor? This page about P2P crowdlending offers you a great introduction to help you start your savings to build a P2P investment portfolio!
When you plan your financial future, you must consider different investment products that can help you achieve your return goals. There are various financial products available to private investors, however, if you do not have specialized knowledge, it can be tricky to start and find the best product that will fit your specific goals. This page will guide you through the world of peer-to-peer lending platforms (P2P investing) and will explain what the most important features are and what you must look for when choosing a platform and why.
What is P2P Investing?
The rise of the fintech industry has opened a way to the establishment of accessible P2P investing. The old school banking goes like this: a borrower goes to a bank to take a loan. Banks have to meet capital requirements to issue a certain amount of loans and are heavily regulated, charging high fees.
New fintech platforms allow to remove traditional banking and get financial services without their involvement, opening loan investment to individuals at a lower investment amount need.
The P2P platforms are an intermediary, just like the marketplace that matches borrowers with lenders. The non-banking financial corporations issue loans to businesses or individuals. On the other hand, there are individuals that want to earn a return higher than offered by bank deposits and less volatile than offered in equity markets. The job of P2P platforms is to match these two parties. The non-banking credit companies are issuing loans to businesses or individuals in the form of consumer loans or car loans, that have difficulty to obtain it in banks, for reasons such as the absence of credit history. Hence, the loans are issued at a higher interest rate, than offered by traditional banks. This allows giving investors a high interest rate. Besides loans, some P2P platforms are offering investment in real estate development projects and some offer both. In this scenario, the loan is issued to a construction company to build a certain project. These loans are usually much larger than business loans.
All P2P Lending Platforms are Different
Some P2P platforms don’t issue loans, not hold any money. They simply bring together and transfer funds from investors to borrowers. But of course, to improve their own reputation and gain more clients, P2P platforms aim to provide added value, such as sourcing loan originators (credit issuing companies) with an impeccable reputation, known for prudent procedures and conservative lending track record. Additionally, P2P lending companies sometimes provide additional due diligence, ensuring that only safe loans with low default chance are presented on their platforms. This makes P2P investing a safe choice for people planning their financial future. The first ever P2P company Zopa is working without intermediaries such as non-banking financial companies, but issues loans directly to borrowers, individuals and legal entities. Such companies are operating also as a monetary institution and require an appropriate license and are regulated by a Financial Supervisor.
P2P Lending Market Overview
The P2P lending industry is relatively young. The first ever P2P platform was founded in 2005, however, the industry saw a rapid rise after the financial crisis, as most of the market participants have lost trust in the traditional banking system. Due to the young age of the industry, there is no centralized statistics source to estimate the true size of the industry. However, there are plenty of independent market research firms, that offer some insights.
The Transparency Market research firm estimated that the market size of P2P lending industry was $ 26Bn in 2015 and predicts that the compound annual growth rate (CAGR) will be 48.2% in 2016-2024 reaching the total market size $ 897Bn by the end of 2024.
American bank Morgan Stanley has predicted back in 2015 that the global industry will reach $ 490Bn by 2020, with US accounting for 45% of total global P2P lending market.
A report by BI Intelligence estimated that in 2015 US P2P lending market has generated $6.6Bn in loans, making it the number one worldwide in loan volume, however, the UK is number one in per capita basis (72% higher than the US).
Europe is the next big market for P2P investing. Cambridge Centre for Alternative Finance has estimated that in 2016 market reached € 7.7Bn.
Until 2018 the biggest market was China which accounted for more than 4000 companies. However, in June 2018 the market collapsed, with many P2P platforms going bankrupt and investors losing their money. The reasons are yet to be investigated, some say it is due to liquidity issues and some say due to the government intervention.
Benefits of P2P Investing
1 – High Interest Rates
One of the most attractive features of investing with peer-to-peer platforms is high interest rate. We currently live during an era of low interest rates and when money sits in the bank account, we might even lose money in real terms, since inflation is higher than nominal interests in the most developed world. In Europe, this problem is apparent: average inflation in 2018 in the EU calculated by Eurostat was 2.2%, while the average interest rate for new deposits in Europe was 0.43% (reference).
2 – Safe Environment
In order to gain customers, P2P lending companies provide additional due diligence for all loan originators and loans that are placed on the platform. This gives customers the confidence to choose a particular platform. The customer should feel like he or she entered a safe environment when collaborating with P2P lending platform.
3 – Freedom of Choice
When you become a client of a peer-to-peer lending company, you get access to the universe of loans that the company has listed. You can browse loans, filter the offerings in accordance with your investment criteria, such as the borrower country, desired interest rate, and maturity date. You decide where to invest and how much, no investment decision will be made without your instruction.
4 – Diversification
When you invest with P2P platform you get the diversification options in one place. With just one product (loans) you can spread your risks between different geographies, maturities, loan types and so on. This is very convenient and easy. With bonds and equities you also get the diversification, however, without financial knowledge it is hard to decide where to invest and there are higher risks.
5 – Safety Cushion
A lot of economic analysts are frightened of the possibility of the financial crisis in the near future. The great recession of 2008 happened a decade ago and the business cycle theory indicates that the next downturn is not far away. For investors, this is a nerve tickling waiting time, as all asset classes drastically declined in price during the last recession. However, the first ever P2P platform was founded in 2005 and it didn’t suffer during the crisis. The return on the UK-based Zopa platform was impressive 4% (reference), when all other investment classes brought losses to investors. Zopa was the only platform that existed before the crisis. All other platforms across the globe emerged after 2009, but Zopa’s experience is very optimistic for those who want to prepare for a recession and earn a positive return in the meantime.
6 – Democratization of Investing
Not everyone can become an investor. Surprisingly, there are high barriers to entry. These barriers are contributing to inequality. The rich are getting richer and the poor are getting poorer. Usually, if you want to have a trading account, you need to deposit quite a large amount of money. If you want to delegate your money to an investment professional, it is very costly too. With P2P platforms, however, these barriers are so low, making them virtually nonexistent. Most of the platforms offer minimal investment starting from as little as € 10 and don’t charge any fees, making it one of the most democratized investment tools.
7 – Controlling the Situation
Many investors have a prejudice against banks, especially after the financial crisis. When you deposit your money in a bank, you don’t know whom the bank is lending your money to. With P2P investing platforms, you are in control. You can choose which business loan or project to lend your money to. Besides that, some companies that are willing to borrow money lack financial history and don’t qualify for a bank loan. However, if the management or the business idea appeals to you, you can choose to lend this company money. This provides an investor with additional satisfaction, knowing that he or she did a noble deed.
8 – Sense of Community
P2P investors do have a very strong sense of community, communicating with each other on a variety of specialized forums. When you encounter an issue or have a question raised, you can publicly discuss it on social media and even get a quick response from the P2P investment platform itself. Additionally, independent bloggers are writing reviews about P2P platforms and describing their own experience in their own blogs.
As with any investment, there are risks associated with P2P lending. You have to decide for yourself what are your financial goals and your risk tolerance. European regulation MiFID2 stipulates that every investment advisor needs to carefully examine the financial situation of each client before making any investment recommendation. In P2P lending market, there are no professional advisors, so you must weigh all the benefits and risks before making any investment. Once you have determined acceptable risk level, you can start investing, but beware that you are bearing all the risks. Below are listed some of the possible risks, which vary from company to company.
Risk of Default
If the borrower is a business or an individual, seeking to raise funds via the platform, this means that they didn’t secure the loan through a bank due to lack of credit history. To compensate for this risk, the high-interest rates are awarded on P2P lending market. However, the lack of credit history means that unreliable businesses or individuals with no means to repay are able to obtain a loan. This leads to a possibility of default. Lending Club, for example, the largest US lending platform had a loan default rate varied from 3% to 14% in different years, depending on the maturity of the loan.
The loan originator goes bust
Another risk that investors may encounter is the bankruptcy of the loan originator. This risk is different for each jurisdiction and the whole economic situation (in 2008 many credit companies defaulted as many borrowers defaulted on their loans). In this case, the claiming rights will belong to investors, not the P2P lending company. It will vary from company to company how they will manage or assist its clients in this adverse scenario. Some companies even don’t mention this topic or prefer not to speak about it not to spook their clients, however, this risk can’t be 100% eliminated.
Asymmetry of Information
Some P2P lending companies are not being transparent about the quality of loans that are placed on the platform. The due diligence process that P2P lending company is conducting is not shared with the investor, so you need to adequately understand this risk by researching the P2P lender and decide for yourself if the yield is compensating your uncertainty.
All eggs in one basket
Peer-to-peer lending is a riskier investment than putting your money in a bank account, however, you get an attractive yield, much higher than in the bank, to compensate you for this risk. Nevertheless, P2P investing is not as risky as you might think if you diversify your funds and put in different securities or products. However, there exists a risk that the P2P investment platform doesn’t offer many diversification options, like limited geographical exposure, and you will end up putting all your eggs in one basket.
P2P investing is working thanks to technology. Even though technological progress has expanded our opportunities, in all areas of life, there are risks associated with it. In the unfortunate event of a cyber attack, the operations will be terminated. So, it would be wise to choose the platform that has a strong IT team behind it.
What to look for when choosing a P2P Platform?
We hope that after discussing the benefits and possible risks you have a clear picture if the P2P investing is the right product for you. Now, if you decided to go ahead and to become a P2P investor, welcome on board! There are many providers on the market and it can be frustrating to choose the best one for you. Below are tips and tricks on how to choose the right platform and what you need to look for in a trustworthy P2P lending company.
In order to eliminate the risk of default, check if the P2P investing company is careful about the loans it places on its platform. How to check that? The company should have strong due diligence procedures, checking the ability of the borrower to repay the loan and if the credit issuer has solid fundamentals to lend such money.
There are a lot of providers and sometimes loans with the same risk profile offer different yields. Due to the rise of P2P platforms, it is natural that the yield decreases during the lifecycle of the P2P lending business. However, beware of P2P investing companies that reduce the yield because they feel that they are already dominating the market, having a solid reputation and decided to take a larger profit for themselves.
Since the platform is a core technology behind P2P investing, look for companies with a strong IT team and developers, who maintain the functionality. The platform should be easy to use but sophisticated in design.
As said before, P2P investors have a strong sense of community. So, the firm you wish to invest with should have feedback in specialized forums, bloggers probably have mentioned it describing their own experience and there are independent reviews available. If the reviews are hard to find or don’t exist, you should be cautious.
When you are investing with a P2P platform you may need continuous support, so it is a good idea to contact the P2P investment company before becoming their client. You can ask about their products or any other topic that interests you and see how responsive and supportive they are.
If the borrower whose claiming rights are placed on the platform for sale defaults, there should be a BuyBack guarantee offered. In this scenario, the loan originator has a contractual obligation to BuyBack the defaulted loan and pay the investor the principal and all accrued interest. Look for P2P lending companies, which have negotiated these terms with its loan originators.
In the scenario that the loan originator goes bankrupt, all claiming rights will belong to the investor. So, in order not to be left alone vis-à-vis the borrower, you need to check if the P2P lending company has thought this case through. It is a good practice that the P2P company informs how it will assist the investors, and whether it will be an intermediary in solving that process. Before committing to a P2P lending company request details on the crisis management procedures when a loan originator fails.
If you aspire to become a P2P investor, you have a good chance to reduce the risk of your portfolio by diversifying your investments. The more differentiated products you invest in, the less risk there is to lose your money. Choose the platform that offers varied investment options. In addition, you might consider choosing multiple trustworthy platforms, as most experienced investors opt for splitting their investments portfolio to minimize risks.
When you invest in loans with a long maturity, you have to wait until the date when the loans have matured to receive your principal back. However, sometimes you may require your money back sooner than the due date of the loan. In this case, it is a good idea to choose a platform that offers the opportunity to sell your investment in a secondary market. For a commission fee, you will be able to increase your liquidity, if there is an interested buyer.
Skin in the Game
This concept refers to the participation of the loan originator in the loan itself and the rest available for sale to outside investors. For example, 5% skin in the game means that 95% of the loan is placed on the platform and 5% would be held by the loan originator. This will ensure that the interests of external investors are aligned with the credit issuing company and will contribute to additional security.
How to Start P2P Investments?
After you have chosen the platform, you can start investing. The procedure is very simple and varies from platform to platform, but the general steps are the following.
To become an investor, you need to complete your identification process, as required by Anti-Money Laundering (AML) legislation. Find out which documents will investors normally need to register on a platform and do you fit the minimal requirements to become an investor (such as age or country of residency).
First, decide what is your budget for investments and begin with a small fraction of it to check how it works, then increase your allocation.
Decide your Desired Term
With longer term loans you might expect higher rates, but at the same time, you’re exposed to higher risks, than with shorter term loans.
When you receive interest payments, in some jurisdictions you are required to pay tax on your investment income. Find out if the platform you are investing with already pays tax on your interest income, or is it your responsibility.
To be confident with your investments, find out what is the procedure to withdraw your available balance and test it right at the beginning of your account history.
I hope that you have enjoyed reading this information and have learned enough to confidently become a P2P investor.
If you have any questions, feedback or suggestions, do not hesitate to contact me at [email protected]
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Check among the P2P crowdlending opportunities available on Savings4Freedom, always taking into consideration that all information is entirely based on my personal experience.