P2P Lending Explained
In the traditional banking system, borrowers go to banks to get loans, and banks then lend money to borrowers at interest. This is how the banking system has worked for centuries. However, in recent years a new type of lending has emerged - peer-to-peer lending (P2P lending). In P2P lending, borrowers borrow money from individual lenders rather than banks.
So, what is P2P lending? And why is it becoming so popular? In this guide, we will answer these questions and more!
What is P2P Lending, and How Does it Work?
P2P lending is an innovative way to borrow money from lending companies instead of banks. Borrowers can borrow quick cash from loan providers in minutes instead of waiting days to get an appointment at the bank.
In some countries, banks are the only institutions that lend money, while in other countries, this isn’t the case, and anyone with a lending license can lend money to borrowers in exchange for interest.
These lending companies are often called loan originators (LOs).
Lending companies don't have easy access to capital, so they have launched their P2P lending platforms that connect investors willing to fund loans with borrowers looking for finance.
Investors can earn attractive yields of up to 16% annually by investing in loans worldwide.
P2P Lending for Investors in a Nutshell
- You invest in a P2P lending platform which is also the loan originator (lending company)
- The lending company lends money to its borrowers
- The borrower returns the loan and additional interest to the lending company
- The lending company deducts a fee and transfers the rest back to your investor account
Can you see how this is similar to banking? Just replace the bank with a lending company!
How to Invest in P2P Lending
Investing in P2P lending is simple. You only need to register on a dedicated P2P lending platform, verify your identity, transfer funds and invest in loans.
Most of the available platforms here on P2P Empire are limited to only European investors. However, there are a few options for investors outside the European Economic Area.
To be eligible to join a peer-to-peer lending platform, you must be at least 18 years old and have a bank account in your name.
If you don't have a EUR bank account, we highly recommend opening a free bank account with or Revolut.
After registering on a platform, verifying your identity, and transferring funds to your investment account, you can use one of the predefined automated investment strategies or invest in loans manually.
The interest is paid monthly or at the end of the loan term. It all comes down to the type of loans you are funding.
Once the loan is repaid, you can reinvest your funds or withdraw them. It typically takes one to three business days to withdraw the available balance to your bank account.
Some platforms offer a secondary market or instant exit option which allows you to liquidate your investments before the loan term and request a withdrawal. This is also why some P2P lending platforms are often used as high-yield savings account alternatives.
The best part about peer-to-peer lending is that you can do it from home, with minimum time commitment and a low minimum investment amount of €10. Those factors make P2P lending a good investment opportunity for many investors seeking to beat inflation.
However, you should know a few more factors before engaging in P2P investing.
The benefits of P2P lending
- Higher interest rate
- Relative good liquidity
- Low minimum investment amount
The disadvantages of P2P lending
- Not fully regulated
- Risk assessment can be complex
P2P Lending for U.S. investors
U.S.-based P2P lending platforms aren't as user-friendly as their European counterparts. To be able to invest on a legitimate European P2P lending platform, you have to pass strict KYC requirements and reside in Europe.
To comply with local laws and regulations, you can earn yield only on deposited stablecoins. We suggest studying our independent guides to get familiar with individual platforms.
Is Peer-to-Peer Lending Safe?
Peer-to-peer lending is safe if you do your due diligence and only invest in loans with a low risk of default.
We at P2P Empire have conducted in-depth due diligence on over 50 P2P lending platforms. Our independent reviews will help you to find the best risk and return ratio in the peer-to-peer lending space. To learn more about protecting your investments, explore our guide about P2P lending risks.
Selecting the best P2P lending platforms and loans isn't that complicated for experienced investors. If you are a complete newbie, we recommend researching platforms and educating yourself about the various risk factors.
Peer-to-peer lending is not risk-free, but if you know what you are doing, you can significantly mitigate your investment risk.
Every investment comes with a particular risk. Understanding the various risk elements is essential in peer-to-peer lending.
Here are four major risk categories that you should be aware of before starting investing in P2P lending.
Platform Risk
P2P lending platforms are subject to business risk as with any other financial service provider. The platform may experience technical issues, have financial difficulties, or go out of business.
To mitigate this risk, we recommend investing in loans from large and well-established platforms with a good track record.
Investing in newly established P2P lending platforms with little to no track record can be risky, especially for inexperienced investors.
Loan Originator Risk
The loan originator is the company that borrows the money from investors to finance its loan portfolio.
Loan originators are subject to business risk as well. They may experience financial difficulties, fraud, or default on their obligations.
To mitigate this risk, we recommend investing in loans from companies with a good credit rating (score cards), good portfolio performance, and a solid financial track record.
Investing in lending start-ups is risky as the management hasn't yet proven that they can build a profitable loan book. You should be cautious about investing in newly established lending companies in emerging markets as it can take several months to build a sound score card for borrowers.
Borrower Risk
The borrower is the person or company that takes out the loan from the loan originator.
Borrowers may default on their loan obligations for various reasons. The borrower may lose their job, have financial difficulties, or simply choose not to repay the loan.
We recommend investing in loans with a low LTV ratio and good collateral to mitigate this risk.
Investing in loans without collateral or with a high LTV ratio is risky as the loan may not be repaid in full if the borrower defaults.
Most of the loans in the P2P lending segment are unsecured consumer loans. If you choose to invest in this loan type, you must rely on the offered buyback guarantee. A buyback guarantee is an obligation from the loan originator to repurchase the investment if the borrower's payments are delayed for a substantial period. This type of protection system keeps you out of defaulted loans.
Market Risk
The market risk represents the economic environment in the market where you fund loans changes.
A new regulation might introduce interest rate caps, putting some loan originators out of business.
If the local currency in which the loan book is issued decreases in value against the Euro, the lender might face difficulties repaying the loan due to unfavorable currency exchange rates.
We recommend diversifying your portfolio across different countries and loan types to mitigate this risk.
Experienced investors with higher investment amounts monitor the currency fluctuation in the markets where they lend money. If you are a risk-cautious investor, we suggest staying out of countries with volatile currencies.
Types of P2P Lending
Different P2P lending platforms offer different types of loans. Some platforms offer more protection for lenders than others.
P2P Lending for Businesses
As an investor, you can choose to invest on P2P lending platforms that offer investment in business loans. Those platforms are often referred to as crowdlending or crowdfunding platforms.
The loans are usually secured by business assets, such as accounts receivable, inventory, commercial pledges, or real estate.
Investing in business loans is a common investment strategy for experienced investors looking to invest in secured loans.
Investing in business loans can be complicated if you don't have enough experience evaluating the offered collateral. We recommend choosing the top-rated peer-to-business platform to avoid bad players in the industry.
P2P Lending for Personal Loans
The most common investment type in the peer-to-peer lending industry is investing in personal loans or consumer loans.
In most cases, you are using a platform to invest in the loan book of a dedicated loan originator, a loan provider in one specific market.
Most of the peer-to-peer lending platforms offer the so-called Buyback Guarantee, which means that if the borrower is late with its payments for more than 30 or 60 days, the loan provider will repurchase your investment and pay you the investment amount together with the accrued interest.
P2P Lending for Real Estate Investors
Investing in business loans backed by a mortgage is the safest investment type in the peer-to-peer lending industry.
All the offered loans come with a dedicated appraisal report that helps you review the value of the collateral backing the loan.
While investing in real estate loans is safer, the investment term is typically at least 12 months, and the minimum investment amount per loan ranges from €50 to €100.
This means that you should consider this investment type only if you are willing to commit your funds for a more extended period.
P2P Lending for Crypto Users
The last investment type in the peer-to-peer lending space is crypto lending.
As a crypto user, you deposit your cryptocurrency on a dedicated crypto lending platform that pays out interest to your account daily or weekly.
The crypto lending platform lends your funds to other borrowers or engages in trading activities.
We have looked into most crypto lending companies, but only a few are good. Many of these companies are just speculating with people's money, which means there is a higher chance that they will run away with your deposits.
If you choose to store your crypto on a dedicated platform, it is essential to research the platform's founders and CEO and the terms and conditions to understand the risks involved.
P2P Lending Strategy
Following a specific P2P lending strategy is recommended to fit your risk appetite when investing in loans. Remember that every single platform is deploying your money to generate yield; hence it has to take risks to offer attractive returns.
It's crucial to differentiate between individual platforms to optimize your P2P lending strategy to fit your risk profile.
The goal of investing in P2P loans is to create a passive income and not to speculate on high-yielding loans where the chance of default is extremely high.
You can define your P2P lending strategy based on the following factors:
- Return: How much interest do you expect to earn?
- Protection: How do you want your investment to be secured?
- Liquidity: How fast do you need to access your funds?
- Automation: How much time do you want to spend on your investment?
- Support & Transparency: Is this something you value?
Remember that the return on your investment is directly correlated with the risk you are taking. Some platforms offer additional protection for your assets in P2P loans, which you can review in our dedicated reviews section.
When testing and reviewing individual platforms, we pay good attention to the aspect of liquidity as this is something you should keep in mind as you never know whether you might need to access your funds sooner than expected.
Many platforms offer an "Auto Invest" which lets you automate your investments so you don't have to spend too much time investing manually. This is an excellent tool for those seeking to earn a passive income.
The support and transparency of various platforms vary. If you are new to P2P lending or someone who isn't that experienced, you should prioritize platforms that offer decent support and answer your questions.
P2P Lending Strategy & Country Risk
You will expose your portfolio to various market risks when investing in loans. It's a good practice to research individual markets and learn more about the lending practices and requirements that the lender has to follow to issue loans. Although it's less risky to invest on European markets, you are never able to eliminate the country risk completely.
Final Thoughts
When investing in P2P lending, it is essential to do your research before selecting a platform. Make sure to read the platform reviews and understand the risks involved before investing.
Now that you have a general understanding of P2P lending, it's time to start exploring different platforms and investment opportunities.
P2P lending can be a great way to generate passive income, but it is crucial to conduct research before investing to understand the risks involved.
We hope this guide has helped you start your P2P lending journey.
