Hello, crowdfunders!
Today we will discuss how peer-to-peer lending works and how to invest on peer-to-peer platforms.
Peer-to-peer platforms connect people who need money with people who have money and want to invest it.
Money is provided in the form of a loan, meaning money is provided for a defined period of time after which provided funds (which is also called the principal amount) are paid back plus interests which are investors' returns and are like rent for using investors' money.
Interests are defined as the percentage of the principal amount per year and calculated from the principal amount for each day it was used by the borrower.
So if the principal amount was 1000 euros and the set interest was 12% per year, if the loan was used by the borrower for a year you get 120 euros if for 6 months you get 60 euros.
In simple words peer to peer platforms allows you to act like a Bank providing loans to private persons.
How to invest in loans on peer-to-peer platforms?
Investment processes might be different depending on the platform and country. There are platforms that provide fixed offers where all parameters of the loan are predefined, and some offer “auction” type investments, where investors are competing by offering better conditions, basically lower interest rates.
The majority of platforms offer so-called Auto invest that allows you to make automatic recurring investments based on your set criteria, meaning you can set the criteria I want to invest in low risk, with interest rate not lower than 10% and loan term no longer 6 months and system will invest your money automatically within your set limit if such loan appears.
Some offer predefined portfolios which are simplified options of auto-invest, you have to choose from a few options which differ by risk and rate.
And of course, option where you see the list with loan requests and you evaluate each request and invest manually.
There are a variety of approaches how to invest and you need to choose a platform that suits your need, but it should not be the main criterion when choosing a platform.
When investing there is main dogma - do not invest if you don't understand risk.
When investing on peer-to-peer platforms the main risk is that the person to whom you gave money, will not be able to repay it and in such case, you will lose money.
Therefore you need to choose a platform that helps you understand risk.
How to evaluate risk when investing in loans on peer-to-peer platforms?
When providing loans to private persons you need to ask this question- does the borrower's current income level sufficient to repay you money? If he will lose his current income source will he be able to find a new one to repay you money?
To answer the first question we need to know two things how much he makes and how much he spends, and if the income (minus) expenses are sufficient to cover payment for your loan then it is good. But of course, it is better if the amount is 20-30% bigger than your payment it provides more security and decreases risk.
To answer the second question we need to know his occupation, experience etc. Basically, you need to try to understand how easy for this person will be to find a new job and here you should use logic since there is no “one fits all” rule.
It might sound like a complex task, but many platforms made the biggest part of the work for you and assigned to each borrower rating that represents the borrower's risk of non-payment.
Using this rating you can understand borrower risk levels without performing an analysis, but I do not recommend trusting the rating blindly.
When you start using any of peer to peer platforms and the platform provides ratings, read carefully the rating calculation methodology and whether it is clear to you how it is defined.
And if the platform does not provide a rating make sure that platform provides enough information for you, to make a decision.
Other aspects to consider when investing in peer-to-peer platforms?
If you will invest actively it is unavoidable that some of your investments will fail, meaning the borrower will not be able to pay. Therefore you need to understand what will happen in such a situation and how the platform will help you to get your money back.
Most likely your investments will be sold to some debt collection agency for a fraction of the principal amount, but make sure that platform has a clear process for such a situation, if it will be on you most likely you will use 100% of the invested amount.
It should be mentioned that platforms that offer investing in private personal loans do not fall under Europen Crowdfunding service provider regulation therefore check is platform regulated on a local level and if is so it will provide more transparency and security.
And of course, profitability is one of the main criteria when choosing your investments. Rates might differ depending on country, niche, and platform and might be from 4% to 10+ %. Therefore review several platforms and find those that offer great risk-reward combinations.
But remember higher rates usually come with higher risk!
Let’s sum it up!
Peer-to-peer loan investing is the simplest form of “understanding risk” which is a very important factor.
Thus if you do your homework and choose the right platform you could make a good return and very well under risk.
If you want to learn more or need to find platforms to invest visit crowdinform.com where we have prepared articles and videos on how to invest and a rating list of Europen peer-to-peer platforms.
Please do not forget to leave your rating and review for platforms that you are already using and if you have a question this is a place where you can ask community help!
It is all for now!
We wish you a good day and successful investing!