Are you among those investors who are looking for investments that can bring maximum returns? In this era where traditional investments and bank saving accounts are offering interest below average, every investor wants his capital to work hard to provide interest that can beat inflation. As a result, many alternative methods are evolving that are providing opportunities to earn high returns. Peer to peer lending is one of the excellent alternative investments that has become popular among investors over a short time. You may have questions like, is it worth investing money in p2p lending? Here we are discussing what investors should know.
What Is P2p Lending?
Compared to traditional investments and saving products, p2p lending is a relatively new concept that was started in 2005 in the UK. In simple words, it matches lenders with potential borrowers that can be individuals or businesses. This process is facilitated on an online platform that allows lenders to deposit funds and borrowers make applications to get these funds. There are several p2p platforms in the UK that deal in different types of loans, including consumer loans, business loans, and property loans. Therefore, you should choose a platform that meets your investment goals.
Investors do not need to go anywhere and can start investing online through a straightforward process. It allows you to earn a high-interest rate compared to standard bank loans. In addition, some p2p platforms also allow you to create an Innovative Finance ISA (IFISA) account through which you can invest your money in p2p loans to earn tax-free returns.
How does P2p Lending Work?
Peer to peer lending is a simple and straightforward process and usually consists of six main steps including:
- Loan Approval
- Electronic transfer of cash
- Loan repayment
Like all conventional loans, the first step of a p2p loan is prequalification. The borrowers must meet the eligibility criteria to secure a loan. The criteria are usually set by the platform, but the investors also have the opportunity to set lending criteria. If they qualify for a loan and like the terms offered by the lenders, they have to submit a formal application. It is a point where the platform carries out a hard credit check to find the creditworthiness of the borrowers.
Once the application is approved, the next step is the funding process. At this point, several investors come to review the loan application and details. Investors can fund the full amount of the loan or a part of the loan under certain conditions. It all depends on the capital and the amount for which a borrower is requesting.
If the loan amount is huge, the funds from multiple investors are pooled together to fund such a loan. The platform transfers these funds electronically to the accounts of borrowers. This transfer may take as little as one working day. The borrower is expected to repay the loan amount plus the interest rate in monthly installments. These monthly repayments are transferred to investors’ accounts.
Advantages Of Peer to Peer Lending
Peer to peer lending offers benefits to both investors and borrowers. Here are some significant advantages:
- You can get high returns on investment compared to other traditional investments. You can even earn double-digit returns if you invest by taking measures to mitigate risks. In addition, there is a chance to invest through IFISA and earn tax-free interest.
- There is an opportunity to create a diversified portfolio and spread investment across multiple borrowers to reduce the risks of default.
- From the borrower’s point of view, the most significant advantage is that they can get quick access to funds. There is no need to go to the banks or complete complex paperwork to get approval. They can go to an online platform and make an application that is approved within a short time.
- Borrowers can get loans at a lower interest rate than traditional loans.
For lenders, the biggest advantage is improved returns. Since it does not involve any middlemen taking a cut from the profit, investors can get more capital gains on their money. In addition, investors can check borrowers’ risk profiles and invest in loans according to their risk tolerance.
Disadvantages Of P2P Lending
Although p2p investment is an excellent alternative investment, like all other investments, it has some disadvantages. The biggest disadvantage, the biggest drawback for investors, is the risk of losing money. There is no security from the government like the Financial Services Compensation Scheme. So, if a borrower defaults, you can lose all your money. However, some platforms offer contingency funds, but these funds are of no use if multiple borrowers default simultaneously.
P2p platforms also allow borrowers with low credit scores to get a loan. However, these borrowers pay high-interest rates. The risk of default is always high. You should always create a portfolio with varying borrower profiles. It can help you in reducing the risks and getting maximum returns.
From a borrower’s point of view, there is no significant risk, but they should research and shop around to find competitive interest rates and select platforms that offer fewer fees and charges.
Always remember alternative investment refers to an asset that does not fall into main investment categories: stocks, cash, or bonds. They can include anything from fine art to real estate and, of course, peer to peer lending UK. The common features of alternative investments include complexity, and they are less regulated and less liquid than traditional investments. One way or other, lenders are taking the risk in p2p lending, but this risk can pay off if the borrower repays on time. One thing that you should keep in mind is that the more the interest rate, the more will be a risk. Therefore, it is always better to look beyond the high-interest rates. It is always worth investing in p2p loans if you understand the risks associated and take appropriate measures to mitigate them. You can make it a steady and regular income source as you receive monthly repayments.