What is P2P Lending?

Peer to peer lending platforms connect individuals seeking loans with individuals seeking a steady return on an investment. These online lending platforms act like traditional financial institutions. Borrowers may go to an online peer to peer lending site and apply for a loan without stepping into a bank. The loan is funded by several lenders who have opened an account on the peer to peer lending site. Borrowers repay the loan with interest in monthly installments to the lenders who funded the loan. Accordingly, lenders expect a steady return on their investment in the form of interest and borrowers expect a streamlined and efficient process to receive a loan. Since peer to peer lending sites automate many of their services and their overhead costs are less than traditional banks, lenders can receive relatively higher returns on their investments. Similarly, borrowers can access loans with relatively reasonable annual percentage rates.

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Lenders

Important Considerations for Lenders

As a lender you are seeking to receive the best return on your investment in a secure and safe manner. Before participating as a lender, it is important to recognize that generally, the assets involved in peer to peer lending are medium to long term investments. As such, these assets are less liquid than a savings or checking account. Though several platforms have a secondary marketplace in which lenders can buy and sell their loans, there are often many fees associated with using the marketplace along with an added level of risk. When reviewing a peer to peer lending site, lenders should consider the following:

• Reported Return Rate
• Default Rate
• Fees
• Features
• Requirements

Reported Return Rate

Keep in mind that each peer to peer lender may calculate their return rate using a different formula. Gaining a basic understanding of how each platform calculates its reported return rate will help you make an informed comparison between peer to peer lenders. The reported return rate calculation may include factors such as the principle loss from charge offs and defaults, late fees paid by borrowers, and fees paid by lenders. While the reported return is a good metric for indicating how well lenders perform on a given lending site, bear in mind that past return rates are not a perfect indicator for future performance.

The default rate is a crucial piece of information to consider when deciding which peer to peer lender is best. This number provides insight into how often borrowers are unable to repay their loans. For example, if a lender invests $100 through a lending site that has a default rate of 5%, the lender should expect to lose $5 from borrowers who do not repay their loan. By comparing the default rate with the expected default rate, you can find out if a lending site is exceeding its expectations and maintaining well-performing loans. The default rate will also provide insight into the peer to peer lender’s credit underwriting practices. Credit underwriting is the process by which a peer to peer lending site assesses a borrower’s eligibility to receive a loan. A high default rate may indicate flexible credit underwriting practices. Lenders should seek out lending sites with less flexible credit underwriting to ensure a reliable return on their investment.

Many peer to peer lending sites charge a service fee, while some do not. To ensure you are getting the most out of your investment, compare the service fees charged by different peer to peer lenders. If a secondary market is available, be sure to check if there are fees associated with selling your loans. Keeping the fee amounts in mind will help you make an informed comparison regarding which peer to peer lenders leave your investment most untouched.

The features of a lending site create a straightforward and efficient investment experience. Some platforms offer features such as automated portfolio recommendations and automated loan selection. Automated portfolio recommendations simplifies the investment process by automatically creating a portfolio consisting of a diverse set of loans. Individuals who are new to peer to peer lending will benefit from using lending sites that offer automated portfolio recommendations. The automated loan selection feature selects and funds specific loans using a set of filters determined by the lender, creating a streamlined and hands-off investment experience. More experienced lenders who know which loans they would like to target may benefit from the automated investment selection feature. Another feature that can be very beneficial is the provision fund. The provision fund is predominantly a feature in the UK peer to peer lending sites. This fund acts as a safeguard against borrowers who are delinquent in their payments. Lenders receive payments from the provision fund in situations when the borrower does not make a payment. If the provision fund is an available feature of a lending site, pay attention to its size as well as how it is funded.

The requirements for becoming a lender vary between lending sites. Pay attention to sites that require all lenders to be accredited investors. The minimum investment amount should also be an important consideration when reviewing a peer to peer lender. The minimum investment amount may be higher for peer lending sites that focus on providing loans for small businesses or mortgages.

Return Rate & Defaults

For peer lending platforms that are transparent with their yield and default rate data for each of their risk grades, FindTheBest has created a breakdown of the effective yield, default rate, and net yield along with the net yield of three portfolios with varying risk levels. The breakdown consists of five risk grades, which provides an objective method of comparing the relative return and default rates of platforms whose grading system may have slight differences. To condense grading systems with more than five grades, statistics were averaged across particular groups of grades. To see what statistics were averaged, visit the Annualized Return Breakdown section in the Details Page of a listing. Please bear in mind that not all platforms are equally transparent with their yield and default rate statistics; therefore, not every listing will have an Annualized Return Breakdown and Portfolio Performance section. The following terms are useful for understanding the Annualized Return Breakdown and Portfolio Performance details:

Diversification

Diversifying your portfolio of investments is an important aspect of optimizing your rate of return. The principle behind diversification is that the positive influence of low risk investments will balance out the potentially negative influence of high risk investments. Low risk investments are safe; however, the amount you receive in return will be less than that of a high risk investment. Essentially, a portfolio consisting of diverse investments will yield better returns with lower risk than any single investment in the portfolio. Accordingly, create a portfolio containing a good mix of both high and low risk borrowers to ensure you are receiving as much as possible out of your investments. An important aspect of diversification is lending money to several borrowers. Investing in only a few borrowers will increase your portfolio’s sensitivity to unsystematic risk.