Peer To Peer Lending: Risks And Returns Ratio
In the past, when someone needed a loan, the only option was to go to the banks or similar financial institutions. But now, you have many other alternative funding sources, including peer to peer lending. It makes the process of borrowing and lending simple and convenient. It brings lenders and borrowers to the same platform and eliminates the need for a middleman or a financial institution. This business was started back in 2005 and became popular rapidly, and now it is lending to billions of Uk businesses and individuals. It brings benefits for both the investors and borrowers. If you are thinking of investing in p2p loans, you must consider its risk and returns before making a final decision.
In this article, we will describe how p2p lending works and its benefits and risks to help you make the right decision.
The way P2p Lending Works
Peer to peer lending is also known as social lending. This type of lending takes place through online platforms. So there is no need to go to any traditional financial institutions. These platforms match investors to the potential borrowers and act as the middle man. There are dozens of platforms in the UK, so you must shop around to find a platform that matches your investment goals. After choosing a platform, you have to create an account as an investor and deposit funds to invest in peer to peer loans. You can set your lending criteria to find borrowers according to your risk tolerance.
P2p platforms carry out all the security checks to choose creditworthy borrowers. In addition, they check the credit score and affordability of the borrower to reduce the risks of default. Every platform operates differently and offers different protections to the investor, so it is vital to do research and find the best one.
Rewards Of P2p Lending
Peer to peer investments offers numerous benefits to the investors. We are discussing some significant benefits here:
Ease And Flexibility
P2p platforms operate online, so it offers an easy way to start your investment portfolio. You can create your portfolio online and start lending to those who are in need of money. All the processes from depositing funds to getting repayments take place online, and you do not need to go anywhere and meet any agent. You can log into your account through any device anywhere in the world and can manage your portfolio.
High Return Rates
In this low-interest rate environment, every investor is looking for an investment option that can bring attractive returns. Here p2p loans help you in achieving this goal. They offer high-interest rates compared to traditional investments and bank saving accounts. Moreover, if you lend money to borrowers who have low credit scores, you can earn higher returns. But you should always keep in mind that the higher the interest rate, the more will be the risk, so you should always invest according to your risk tolerance.
Another benefit of investing money in p2p loans is that it provides you with an opportunity to diversify your investment portfolio. You can add it to your portfolio along with other assets to maximize returns. Diversification is a key to reducing risks. Peer to peer lending UK ٗ allows you to diversify within this investment. Instead of investing all your capital in a single loan, you can spread it across multiple borrowers. It helps you in lowering the risk of borrower default. If one borrower defaults, you can continue getting profit from other loans. In addition, some platforms have an auto-invest option in which you only need to deposit funds and set criteria, and the platform spreads your investment automatically across multiple borrowers.
You can also earn interest from peer to peer loans in a tax-free wrapper. Many platforms offer the opportunity to create an Innovative Finance ISA (IFISA) account and invest your annual allowance in peer to peer lending. This way, you can earn tax-free interest and maximize your returns.
Risks OF P2p Lending
P2p investment is a financial product, and like other products, it has some risks along with benefits that you should always keep in mind.
Most p2p platforms deal in personal loans that are unsecured. It means there is no security and more risk of losing money for investors. The most significant risk in this type of investment is the risk of losing money if borrowers are not able to repay the loan on time. However, there are platforms that offer property loans that are secured, so you should invest in such loans to reduce risk.
No Protection By Government
When you invest in standard bank loans, your money is protected by the Financial Services Compensation Scheme (FSCS). But it is not the case when you invest in peer to peer loans. It means you can lose all your investment in case of a borrower’s default. Some platforms offer contingency funds to cover the defaults, but it is of no use if multiple borrowers default simultaneously.
There is another risk that is associated with the p2p platform. It may happen that a platform goes out of business or goes bankrupt. It will become difficult for you to get your money back in such situations. However, the Financial Conduct Authority (FCA) now makes platforms to place investors’ money in ring-fenced accounts. Therefore, you should always invest through a platform that has a good reputation in the market.
Now that you know both the risks and rewards, you can better decide whether it is the right option for you.
Peer to peer lending can be an excellent alternative investment to earn a regular income. You can balance the risk and reward ratio by taking appropriate measures such as choosing the right platform, creating a diversified portfolio, and spreading your investment across borrowers with varying risk profiles. Moreover, you should always start investing with a small amount, and once you understand the process, you can increase your investment. If you take measures to reduce risks, you can get double-digit returns and also enjoy the benefit of compounding interest when you keep on reinvesting.