Peer-to-peer investments seem like a no-brainer. The advertised rates seem to make it a simple decision – who wouldn’t want to earn high interest rates on their investments? As they say, though, with reward comes risk and P2P lending is no exception. You know about the risks the stock market poses, but what about P2P risks?
P2P lenders invest in individual borrowers, like me and you. An applicant applies on the peer-to-peer website. The P2P company rates the borrower based on standard qualifications including credit score and employment/income information. Investors choose loans to invest in based on these ratings. The higher the risk you take, the more interest you earn. You can reduce your P2P risk by investing in ‘highly rated’ loans.
But what happens when a borrower defaults? As the investor, you don’t get paid. You lose the portion you invested in that loan, which is why diversification is crucial.
Similar to borrower default, you run the risk of borrowers becoming unemployed suddenly, as we’ve all seen during the COVID-19 crisis. With unemployment usually comes the risk of default as the borrower no longer has the job he/she had upon application.
When you transfer funds to your P2P account, it sits idle. Since peer-to-peer lending is a marketplace based on supply and demand, there may be times that your money sits unused. This can reduce the returns you earn if your money sits for long periods increasing your P2P risks.
Peer-to-Peer Site Failure
There’s no guarantee a P2P site will stay in business and/or solvent. While the FCA requires sites to create plans that ensure borrowers still make their payments, there’s no guarantee investors will receive their payments as agreed.
Interest Rate Risk
Once you invest in a loan, you’re locked into it for the term. If interest rates increase, you are stuck with the rate agreed upon with the borrower. While rates may not often increase beyond what you earn, the P2P risk is there.
Cybersecurity or fraud are both real risks when conducting any investment transactions online. You run the risk of fraudulent activity occurring in your name or even on the platform itself. It’s best to work with platforms that have strong security measures to avoid this risk.
Lack of Liquidity
Once you lend a borrower money, the money is tied up for the term of the loan. If you need to get out of the investment, you’ll have to sell it to another investor, which isn’t always easy to do. Some larger platforms do offer secondary markets for this reason, so if you think you’ll need liquidity, make sure to look for the right platform.
All investments have risks. It’s understanding the risk and determining if it’s something you can handle that matters. Assess the risk of any platform, know how they handle defaults, whether they have a secondary market, and how serious they take security when determining which platform is right for you or if P2P risks are something you can handle.