Peer to Peer Investing


Guide to Peer to Peer Investing

Peer to peer investing has advantages made possible by the weaknesses of traditional personal finance choices.  Personal loans carry a large interest rate from the bank.  This is something that is well-known and can dissuade people from taking out money to do a project or satisfy a need.  Thus a desire to go on an expensive family trip, do an addition without refinancing, pursue adoption, etc. can go unmet through traditional lending means.  Yet as an investor you might find that you can help someone save at least some of the high interest payments while still getting a good return from someone who has a proven track record of paying their financial obligations back.  These are peer-to-peer loans and they can be mutually beneficial.

Of course the first decision you need to make is what kind of peer-to-peer lending you want to pursue.  Much of the information on this page is a bit general, and there may be specific aspects of each type of peer-to-peer lending that you should keep in mind, as follows:

  • Peer to peer loans for individuals and families: These are the most common and easiest peer-to-peer loans to invest in.  You will need to do your homework as far as what criteria you want to use to filter through the asks – everything from credit scores to years of employment to years since their last default can be used as a filter.  You’ll also have to understand how these factors affect returns – only lending to those with perfect credit scores and financial histories is likely to get you smaller returns but lower risks, for example.
  • Peer to peer business lending: This type of peer-to-peer lending investing carries the most risk but can also be very rewarding on several levels.  You are providing a loan to a start-up or small business to help it become successful.  Often these types of loans require a larger investment, and may require a longer payback time.  They also require quite a bit more homework given that in many cases there is little history and only the promise of the business plan to judge things on.
  • Peer to peer real estate lending: There are two types of this segment of peer-to-peer lending investing: residential and commercial.  Residential itself has two parts and they are mortgage lending for individuals and families that will occupy the house, and lending to developers who may end up renting or fixing and flipping the property.  The most common types of peer-to-peer real estate lending investing are commercial and lending to developers.  There are many more regulations on these two types as well, and you may have to be an accredited investor to invest.
  • Peer to peer student loans: These instruments are not readily available but may emerge as a viable option for both investors and students.  Ad the cost of education outstrips the reasonably low-rate student loans available, we could see growth in this form of peer-to-peer lending investing.

There are other subsets as well, such as peer to peer investing for the military, peer to peer lending to those with bad credit, and others.

Peer to Peer Investing Process:

Peer-to-peer investing may not have the payback potential of equity crowdfunding or crowdfunding for start-ups, but if you are careful and do your homework the returns can be steady and positive.  Peer to peer lending can also help an investor fulfill her or his own mission, perhaps to give others a chance at success or the opportunity to do something the investor supports.  The process of peer-to-peer investing is quite simple, as follows.

1. What Type of Peer to Peer Loan?

Choose what type of P2P loans you want to pursue.  Do you want to give person to person loans across a wide variety of projects and people to hedge against risk, or are you looking to invest in just one or two people and purposes?  Are you getting involved for the highest return, or to fulfill a purpose?  Do you want to fund a project that does not take too long so that payback begins sooner, or are you okay with waiting a little longer for your person to person loans investment to pay off.  All of this needs to be a part of your decision-making about the types of peer-to-peer lending investing listed above.  For example, those of you looking to invest in order to motivate a certain cause, such as allowing promising students the chance to get a certain type of graduate education, or allowing people who cannot afford an initial lump sum to adopt children, may have an easier time finding a potential investment.

Even if you do not have a specific cause in mind, you can still think of ways to narrow the field as far as peer-to-peer loan funding. Do you want to invest in promising brand new products, or in the expansion of a so far successful business? Do you want to give an entrepreneur a chance, or stick with someone with an established product? Are you thinking about an educational person to person loan because you want to invest in someone’s future potential, or a training loan to help an already successful person improve their competitive chances?

The type of peer-to-peer loan you choose may also be guided by less obvious factors, including length of payback, risk, and the opportunity to re-up. For example, crowdfunding investing in a four-year education of a promising student may led to a longer payback period and a bit of a wait until the first payment comes. Obviously this wait is balanced by the fact that most crowdfunding person to person loans do not have grace periods as far as interest accruing, but you still may want the full payback sooner.

The risk in crowdfunding person to person loans may be hard to measure within a type of loan, but measuring risk between entire types of loan is much easier. In other words, you may have trouble deciding exactly which graduate student to fund when it comes to risk, but you do know that funding a very promising medical student is less risky than finding a promising musician. And overall, funding a graduate degree may be less risky than funding a new product launch for a small business.

2. Which Peer to Peer Lending Website to Use

Choose the website or other means of finding person to person lending opportunities.  You want to choose the best peer-to-peer investing website for your purpose, so if you want to know a person’s history of financial responsibility you’ll want to choose one that makes the person describe this.  If you want certain other information you want to make sure that your peer-to-peer  investing website asks what you want to ask, or gives you the opportunity to ask this yourself.  And you’ll want to choose a person to person lending website that specializes or at least includes the areas that you want to fund.

3. Narrow Your Choices

Look at the pitches that people are making who want a peer-to-peer loan.  Read through what they are looking for and how they feel they will be able to pay things back.  Read a wide variety of applicants’ information because it will give you an idea of the potential for peer-to-peer lending that is out there.   Decide what you might use as a measurement for which peer-to-peer investing opportunity you might pursue.  And if possible get in touch with some of the applicants for whom you want more information.

4. Make a Choice

Now it’s time to choose a few finalists for your peer-to-peer investment.  If you want to invest in peer-to-peer lending you want to choose these finalists and ask questions, have them put a little more work into their application, and negotiate what the terms will be of payback.  In some cases some of this is decided by the website you are using for your crowdfunding and peer-to-peer investing, but sometimes you can have the applicant go the extra mile.  Not only does that help you get the additional information you need, but it also shows how hard the applicant is willing to work.

The opportunity to re-up is an uncommon but possible factor in choosing a crowdfunding person to person loan. An obvious example would be finding the MBA of a promising student and then subsequently funding her or his first product launch as well. Or maybe funding the first new product of a business and coming back to fund the second with another peer-to-peer loan. Some investors like the idea of following up with a person who they’ve given a person to person to person loan because this feels less risky and more relationship driven.

Crowdfunding has been refined to the point that returns are strong and steady if you choose the best crowdfunding site for your needs, and choose the actual peer-to-peer loan you will fund carefully.

Aggregate Peer to Peer Investing

There is another alternative to the above that can make peer-to-peer investing much easier, and that is merely joining in with a group of investors who are providing peer-to-peer loans in the aggregate.  In other words, you trust a website or perhaps an individual who is vetting applications to decide which group of individuals deserves and will be able to pay back the loan, and this group then becomes who you invest in.  The advantages of this method of peer-to-peer investing include spreading risk over a larger group of recipients, and you not having to do the extensive research that would otherwise be needed.  You may be able to get a reasonably accurate idea of what this same type of group has been able to lead to as far as return to the investor in the past.   The disadvantages of course have to do with the process taking away some of your own discretion, and it may subtract some degree of meaning from those who have a particular cause or reason to provide these investments.

For this type of aggregate P2P lending you’ll basically choose the return you want and the risk profile you are willing to take on, and perhaps the length of time until you expect to be paid back.  You will also in some cases choose the reason that the people are asking for the investment, although sometimes these reasons are not given and in some ways not relevant.  In this type of person to person lending there are pluses all around, with investors getting a payback on their loan that is higher than many other forms of investment, while the person getting the loan gets a discount off of the amount they would pay for a traditional bank loan.  Lending Club and Prosper (not affiliate links) is one of the best known peer-to-peer lending online institutions.  Wikipedia has a helpful entry on Peer to Peer Investing that includes some interesting legal history and background.

Peer to peer Investing Advantages

The advantages of peer-to-peer investing revolve around the returns.  You can easily do better on these types of investments than you can on many types of traditional investment.  Most peer-to-peer loans sites will publish that average historical returns for each type of investment so you can see what you are likely to earn, and the main advantage will be that you can get much more than some types of investment like a CD, and in many cases at least as much as investing in the stock market with less short-term risk.   Of course there are other advantages as well, including:

  1. You may be able to fulfill a personal mission of some type through peer-to-peer investing.  Maybe there is a type of person or a type of goal that you want to help fund.  Or perhaps you just generally want to be able to help people meet their goals in ways they could not if this type of lending was not available.
  2. You can mix and match risk levels if you do some peer-to-peer investing in the aggregate – trying to get some higher returns with more risky loans while at the same time having a base of less risky loans as well.
  3. This type of investment is easy.  Most good peer-to-peer loans sites allow you to invest and then sit back and watch your returns.  It is not difficult and especially if you do your lending in the aggregate you can really take a passive yet enjoyable stance.

Drawbacks to Peer to Peer Investing

Peer to Peer investing is not for every investor.  There are drawbacks, at least as compared to other forms of investing, and they include:

  1. P2P loans can be risky, especially if you do not do your peer-to-peer lending in the aggregate.  If you provide an investment to only a small group of people you run a higher risk of not being paid pack or being only partially paid back.  So while carefully choosing who to invest in may make sense in some cases, ir may also increase the risk.
  2. P2P loans have a cap on your return.  Many other types of investments may ebb and flow, but overall there may be little ceiling on the return.  Of course peer-to-peer loans have a ceiling equal to the interest rate you are charging.
  3. Peer-to-peer lending investing is not available in all states, so they may not be an option where you live.
  4. Finally, peer-to-peer investing may make it hard to withdraw on your investment.  You may get paid back gradually and even though in the end you get a good return, you may not have the flexibility to get your money back out if you need it.

You will need to carefully assess all of the unique advantages and disadvantages of peer-to-peer investing for you given your unique financial situation.

Conclusion

While crowdfunding is usually though of as investors providing money for a specific product or purpose that has some specific value, a value that is either expected to rise or relates to the investor’s own mission, peer-to-peer loans are more about fixed interest rate investing designed to replace traditional bank lending.  Peer to peer loans are still a subset of crowdfunding, but in many cases they look different.  Do your homework and you might find that Peer to Peer Investing is for you!