What is Peer 2 Peer Lending?
"Peer-to-peer lending, sometimes abbreviated P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders directly with borrowers."
What is Peer 2 Peer Lending, Really?
It is commonly talked about how it is a form of crowdfunding or the latest buzz word, crowdlending. The lending platform, or website, matches up people who need to borrow money with those people who want to invest money. The lending platform provides the website front end for the borrowers to apply for the loans, and the investors to fund their accounts so they can pick loan notes (normally at least $25 increments) to invest in.
These borrowers, who may not be able to get loans from traditional banks, pay loan interest rates depending on their credit scores. The interest rates they pay can be anywhere from just over 5% to 25% on average. The loans are normally either 36 month or 60 month terms, and can be from $2,500 to $35,000 dollars. Most of the loans are for categories like loan consolidation, credit card payoff, or small business startup, among others.
For the investor, these types of loans are attractive as they offer the potential to earn high interest on the money they invest. As with any type of investment, this one also has risk. If the borrower fails to pay their loan back, and the lending platform cannot recover the money through legal channels, you have lost your unpaid investment for that particular loan.
Here is the good part: to help reduce your risk, you do not fund any one single loan completely. Crowdfunding involves many people funding a project, or a loan in our case. Every loan note is a portion of the overall loan amount for that borrower. To make this easy, the most common strategy is for you to invest minimum amounts of $25 in several different loans. Remember, these loans are unsecured, so you do want to reduce your risk where you can.
For an example:
If you have $100 to invest you would buy four notes at $25 each, each note belonging to a different loan applicant. You may have noticed that $25 plus the interest paid back monthly over a 36 month term will not give you much monthly income. The average payment is more like $0.75 or so for each note monthly payment. That does not sound like much, unless you have 100 notes. Then you monthly payments (principal plus interest) could be more like $75.
This can sound simple enough - until you start trying to determine your investment strategy. The investor is provided with a profile that describes some of the loan applicant's financial background. The applicant themselves are anonymous to us.
When you review each loan, you can see information such as:
1. The loan amount, term, and expected monthly payments.
2. The applicant's length of employment, job title, and monthly gross income.
3. The applicant's debt to income ratio, credit score range, and any delinquent credit payments over the past two years.
4. The state the applicant resides. This can be important if you are considering which states have recurring natural disasters or high unemployment rates for your investment strategy.
Where Did Peer 2 Peer Lending Come From?
During the financial crisis started in the early 2000's, borrowers were not able to get loans from traditional banks. As a response to this issue, crowdfunding became a popular response.
Peer 2 Peer Lending, a form of crowdfunding, started in the United Kingdom in early 2005. The pioneer online company is Zopa. About one year later, the United States responded to this new popular crowdfunding method with Prosper and Lending Club.
These crowdfunding transactions were highly unregulated until 2008. The Securities and Exchange Commission required these companies to register as securities. Zopa dropped out of the U.S. market. As it evolved and grew, the Peer 2 Peer financial platform has become available to individual and corporate investors in many countries.
As of June 2015, Lending Club is known as the largest Peer 2 Peer company in the world. It is also the first Peer 2 Peer company to join the U.S. Stock market. They went public in December of 2014. Their Stock Ticker code is "LC".
How Does the Lending Platform Make Money?
The lending platforms make money by charging the borrower fees similar to loan origination fees, and then charge fees to the investors for services like processing payments.
Are the Lending Platforms Safe?
These lending platforms have evolved over the past decade. Initially there was no transparency and few restrictions on the borrower's eligibility. Within a few years, the Securities and Exchange Commission (SEC) required the platforms to register their loan services as "securities". The SEC now has oversight and monitors them.
As the loan terms are normally 36 or 60 months long, the concern was raised that investors could not liquidate their assets in a timely manner, like they do selling equities (Stocks). In response to that concern, the two major U.S. players (Prosper and Lending Club) got together and created a partner called Folio to make a secondary market.
The new secondary market is a place where investors can sell their notes to other investors if they need to liquidate their assets.
Why Invest in Peer 2 Peer Lending?
As an active dividend growth investor (DGI), I have been watching the economy and markets for over ten years. I am always looking for new and alternative (legal) ways to invest my money to earn a good return.
I began reading about peer 2 peer lending in 2013 in major financial news outlets and have been monitoring them since.
In January of this year (2016), we decided to try a test investment run in Lending Club, as Prosper is not accepted in my current state of residence.
I am watching the "LC" stock behavior as well, but it does not pay dividends yet, so it does not fall in my investment strategy.
I have created a Blog to track our investment experience and to encourage collaboration with other P2P investors.