Peer to peer lending is a stable and resilient type of investment offering investors a great alternative to traditional investment options. Using peer to peer platforms, investors can invest in p2p loans and can get a high rate of returns. All the processes, from making an account to receiving loan repayments, are online.
That is why investors find it more convenient than conventional investment methods that include lengthy paper works. Although p2p lending has many benefits, like all other investments, it comes with some risks that you must consider before investing.
Peer To Peer Lending | Platform Risk
Choosing the right platform is the most challenging task when it comes to investing in peer to peer lending. The platform that you have selected may be itself fraudulent. A platform may suddenly go bankrupt, and investors have to lose all of their money in such cases.
You should invest in a platform that has been present in the market for several years so that you can check the track record. You can also check the transparency by checking online reviews by investors.
Peer To Peer Lending | Borrower Defaults
It is the most common and significant default that an investor can have when investing in p2p platforms. Most of the loans are unsecured, and if a borrower defaults, there is no asset of the borrower you have that you can sell to get your money back.
You keep in mind that the more the interest rate, the more will be a risk. If you avoid this type of risk, you should spread your investment across multiple loans so that if one borrower defaults, you can get the profit from the other loans.
Moreover, you should choose borrowers of different risk categories to avoid the risk of default.
Peer To Peer Lending | No Protection By Government
When you invest in traditional bank loans or savings, you have protection from the government in case of losing your capital. In peer to peer lending, your investment is not secured by any government scheme like Financial Compensation Services Scheme (FSCS).
It means if a platform goes out of business or borrowers default, your money might be lost altogether. Some platforms offer contingency funds to cover their investors in such situations. But this fund also is of no use if a number of borrowers default at the same time.
Diversification is the key to reduce the risks of losing your money. You should diversify your investment portfolio and always start from the small capital so that you will not lose all of your money if something bad happens.
Peer To Peer Lending | Market Risks
Market risk is an external macro factor that can affect your investment. It can include currency risk, country risk or political risk. All of these things can affect the demand for p2p investments and the supply of p2p loans. Most investors do not consider this risk when making investments.
However, the changes in the economy of the country impact the p2p market significantly. For example, in the coronavirus pandemic, some p2p platforms closed because the borrowers stopped loan repayments, and the platform could not handle the pressure. The best way to minimise market risk is to make sure that your portfolio is well diversified.
Now that you know all the major risks associated with peer to peer lending, you can make a better decision whether you should invest in p2 loans or not. However, you can make p2p lending the best way to earn money if you follow all the necessary measures to mitigate risks.