Peer to peer lending gained a lot of momentum in the last 10 years. More and more people every day choose to take out their funds from their bank accounts and invest them in a p2p lending platform.
Where do these crowd investing platforms come from?
There are multiple factors that contributed to the rise of these alternative investment types.
On one hand, since the 2008 financial crisis, bank loans are a lot harder to obtain, for both individual borrowers and small companies. So, these potential borrowers don’t go to banks anymore and look for an alternative solution.
On another hand, the interest rate on a savings account is so low, that keeping money in a bank only means losing them to inflation. So, people with savings accounts look also for alternative ways to make their money work.
There’s also a general negative sentiment towards banks that adds an incentive to people who want to withdraw their funds from the banks.
Another factor that contributed to the rise of peer to peer lending is that new regulations in many countries provided a legal framework for crowd investing platforms to develop.
And, of course, technology is sufficiently evolved these days that you can transfer money from one account to another in a matter of minutes or days at almost no cost. And it also makes it easy enough for borrowers and lenders to meet and exchange funds without too much fuss.
The direct result of these factors is that we have today a plethora of crowd investing platforms among which are:
- Websites that offer personal loans, like NEO Finance
- Marketplaces that offer loans from lending companies, like Mintos
- Platforms that offer small and medium business loans, like Monethera
- Websites that offer loans backed by real estate mortgages, like Grupeer and Bulkestate
- Platforms offering investments in rental properties like Property Partner and Housers
- Green energy investments platforms like Abundance Investment
- Equity crowd investing platforms like Seedrs and Crowdcube
And many more.
Are my investments safe? No
All these platforms are regulated by their local financial authorities and they do offer some protection for their investors and borrowers.
But, as opposed to keeping your money in a bank account, there’s a lot more risk involved when you venture in the p2p lending world.
The bank accounts are typically covered by a protection plan up to a certain amount. European bank accounts are covered up to 100.000 EUR. If the bank you keep your money in goes bankrupt, you’ll get your funds back from a special fund designed for this type of situation.
Even stock trading platforms have some protection mechanism for investors. Degiro, for example, has a protection fund that covers your investments up to 20.000 EUR in the event they go bankrupt.
On peer to peer lending platform, there’s no such thing as a protection plan.
How do you choose the right platform?
So, how do you choose a peer to peer lending platform that is safe enough that you minimize your risks of losing your investments?
When I started to invest in p2p lending platforms, this was my decision flow:
- I heard about p2p lending platforms and I wanted to get in
- Searched on Google “European p2p lending platforms”
- Ignored all ad-related results – I generally don’t trust ads
- Found lots of blogs talking about Mintos, Bondora, EstateGuru and a few others
- I’ve read a few blog articles, learned about loan types, loan originators, interest rates, loan terms, buyback guarantee, etc.
- By this time all was fuzzy in my head so I almost randomly created an account on Mintos, just because nobody had a bad word to say about it
And this is how I’ve invested my first 10 EUR on Mintos. Then another 100 EUR, then 1000 EUR. Then a few more, until I realized that I shouldn’t put all my eggs in one basket and started to diversify.
Since then, I read a bit more about peer to peer lending and I like to think I’m wiser when I choose the projects and platforms I invest in.
What to look for when you look for the perfect platform?
Research the company that owns the platform
How easy is to find information about the company that owns the platform?
Do they have a business address on their website? This would mean they’re at least a real company and some legal authority oversees their activity.
Can you find out who are the company owners? If they want you to trust them with your funds, you should at least know who they are.
Is the company regulated by some legal authority? Are they allowed to provide crowd investments? Common regulations regard details about where your funds should be kept, who handles your investments if the company goes bankrupt, minimum funds they’re required to keep in order to ensure their financial health and legal obligations to act in the investors’ best interests.
Do a search on Google about them. What do the past or current users say about them? Do they have good feedback?
If the answer to any of these questions is no, that’s a warning flag and you should stay away from them.
Research the platform
Do they have enough loans to keep the platform running?
These crowd investing platforms make money by charging the borrower (and sometimes the investor too) a fee on each loan they fund. How much they charge should be visible in their FAQ section on the website.
If they don’t have a constant flow of loans on the platform, they won’t be able to survive. And your investments would be at risk because the platform is at risk of default.
What are the fees they charge?
Do they charge you when you deposit or withdraw funds? Do they charge you when you invest in a project or when you collect your payments? If yes, how much? Does it still make sense to invest on the platform if the fees are too high?
Where are your funds kept?
Your funds must be kept in an account separate from the platform’s bank account. If they default, you don’t want company creditors to recover their loans by using your funds.
Your investments, as well, should be kept separately from the company assets. This means that your name must be on the investment and the platform should act only as a nominee. Or, at least, your investment should be in a legal entity separated from the platform.
All these are to ensure that in a “worst-case scenario” when the crowd investing platform goes bankrupt, your funds and investments are still safe.
What security do they offer for your investments?
Some of the platforms offer loans secured by real estate property. This means that if the loan defaults, you’ll recover your investment from the sale of that property.
But you’re not completely out of the weeds.
Recovering funds from the sale of the property take time, so you might not see your money for a while.
If the loan to value ratio is too high and the real estate market is down, the property would not be at the same value as it was at the beginning of the loan and it might not cover the initial investment.
Also, for loans secured by company assets, is it a first charge or second charge security? A second charge means that you get whatever’s left after the first charge lenders recovered their funds.
Some p2p lending platforms offer a buyback or payment guarantee. This means that if the borrower is late with their payment or if the loan defaults, the platform would either buy back the loan from you or continue to provide the interest payments from their funds. This would generally mean they charge the borrower a much higher interest rate than the one offered to you on the platform and they have enough funds to cover for bad loans.
Some other platforms create a provision fund (you contribute to it along with other investors) that would cover the interest payments for the loans that are either late or defaulted. This would mean you would get lower returns for the loans, but they’d be safer.
And then there’s a special group of platforms that offer no security for the loans you invest in. They offer instead higher returns. You’d need to spread your funds in as many investments as possible, so you still get a nice profit even with a high rate of defaulted loans.
What is the length of the loan terms available on the platform?
If you only expect to invest in a peer to peer lending platform for a few months, it doesn’t make too much sense to invest in 5-year loans.
What are the interest rates offered on the loans?
This is an important question. If you do get involved in a p2p lending platform and expose your funds to higher risks, you should do it for the right amount of money.
If the expected gains don’t justify the risk, don’t do it. (you can quote me on that)
You’ll need to compare the loans with the ones offered on other platforms. Do they have better returns? Do they offer the same security? If so, move on to the other platform.
What are the default rates?
What is the percentage of the loans that default? Is it low enough to justify an investment there? All serious platforms should have a FAQ section or a page with statistics related to historical loan defaults and late payments.
Some of the platforms out there are relatively new so they don’t have too many statistics regarding historical default rates. If you invest in a newer platform, this is an additional risk you’re going to take.
What is the minimum investment required?
It makes a big difference if the minimum required for investment is 1 EUR or a few thousands EUR. How much are you prepared to invest in a single loan?
What currency are the loans in?
Exotic currencies might offer better interest rates but the risk of losing all the profits due to inflation is also high.
How easy is to exit your investment before the end of the loan term?
This is especially important if you need your funds for an emergency. Or if you found a better investment opportunity. Or for whatever reason.
Does the platform allow you to sell your investment before the end of the loan term? Does it have a secondary market where you can sell your investment to other users? If not, does the platform provide you with the option to sell your investment back to them, even if for a fee?
How is your investment repaid?
Is the loan paid in monthly instalments or only at the end of the loan term? If it’s in monthly instalments, does it include a portion of the invested principal or just the interest payments?
If the loan is only paid at the end of the loan term, and there’s a similar platform that offers loans with the same interest rate and with monthly instalments, the second platform is a better choice. You can invest those monthly instalments into new loans and get more profits.
Can you diversify your portfolio to minimize the risks?
Does the platform have enough loans, so you can spread your investment in small amounts and multiple investments? Even if a few loans are late or defaulted, you’d recover your investment from the many others that didn’t default.
Does it offer loans from different countries or different regions of a country? If one country goes through an economic downturn and businesses declare bankruptcy and people lose their jobs, your investments should be all tied up to only that one country.
What types of loans are available?
There’s a myriad of loan types available:
- Short-term unsecured loans
- Personal loans backed by mortgage
- Car loans
- Business loans
- Invoice financing
- Bridge loans
- Real estate development loans
And a lot of other loan types that I can’t remember the name of.
This might not look important at first, but they all come with different levels of risk. Investing in multiple types of loans should also minimize your risks.
If the platform doesn’t offer you the level of diversification you need, you can either move to another one or invest a smaller part of your funds into it and expand your portfolio to a different platform as well.
Does the platform have an auto-invest tool?
How much time do you want to invest in peer to peer investments? If you plan to invest in a p2p lending platform for a few years, would you log in every day on that platform to invest your funds in new loans?
This is especially important if you invest from 10 to 50 EUR in hundreds of consumer loans on a platform like Mintos. All of them have different repayment schedules, so there’s a continuous drip of small interest payments in my account every day.
My Mintos portfolio is on auto-pilot and is as close to passive income as it could get. I’ve added funds to my account, set up an auto-invest profile, and log in on the platform once every few weeks to see how my funds are doing. If there’s something out of order, I do a small tweak on my auto investment profile, and then come back in another few weeks.
Do you get any bonuses for investing in a platform?
It’s a very competitive industry and many platforms offer sign-up bonuses or cashback on the investments you make on their platform.
It’s an aspect to consider when you check your potential investment return on a specific platform, besides the interest rates on the loans provided.
Does the platform invest in the loans it offers?
This is called “skin in the game” and makes sure the company that provides the loan has your best interests. If the loans they bring on the platform are bad, they’ll be affected too.
I’m not really sure if this is an important point for me, because there are other more effective ways to punish a lending company.
If a platform has a high rate of defaults, it will lose a lot more due to loss of credibility and reputation than what it loses from those defaulted loans. News travels fast and soon there won’t be any investors to keep their funds there.
How long do you plan to invest?
Are you in for a short run or do you expect to keep investing in p2p lending platforms for years to come? There’s no easy answer to this, at least it’s not an easy one for me.
Do you see loans from an ethical perspective?
Can you invest in high return payday loans? Even if you know there’s some poor guy somewhere living from paycheck to paycheck that gets charged 100% or more interest rate for the loan the lending company let you invest in?
Would you rather invest in business loans or consumer loans? The first ones help the economy by creating jobs and bringing real value to the economy. The second ones keep the consumer society we live in spinning.
Would you invest in a green energy project instead of a bitcoin mining facility, even if the latter has a higher return on investment?
These are also valid questions to ask yourself before adding your funds to a specific crowd investing platform.
How much money are you comfortable to invest?
What percentage of your portfolio are you comfortable to put into crowd investing platforms?
If the answer was 100%, that’s not a good answer.
For me, my comfort level is at 10-20%. For you, it depends on your own risk profile.
Crowd investing platforms can offer better returns than a lot of other traditional investment options, but they also come with greater risks.
Why do you want to invest in a peer to peer lending platform?
Do the high returns compared to other types of investment attract you?
Do you find p2p lending as a viable passive income stream?
Do you like the fact that it’s easy to start with a small amount of money?
Are you genuinely a good person and just want to help others by providing them with the funds they need?
There are many reasons to get into p2p lending and other forms of crowd investing. What’s yours?
Leave a reply in the comments section.
That’s all, folks!
If any of the ideas put in this article made you think of something interesting, please let me know in the comments section.
You might also find of interest this article where I describe how the crowdlending platforms work and why they thrive.