How to Invest in Peer-to-Peer Lending

Peer-to-peer lending, also known as P2P or person-to-person lending, allows everyday people to borrow money from and offer loans to other people without using a bank as an intermediary. Online peer-to-peer lending platforms, such as Lending Club, Prosper, and several others, allow investors to browse lending opportunities from carefully screened borrowers.

Potential investors should keep in mind that P2P loans are unsecured. However, borrowers who solicit loans on P2P networks must have acceptable credit scores, credit history, and income levels in order to post an advertisement. This mitigates much of the risk. Loans to high-risk borrowers naturally have higher interest rates, while borrowers with good credit qualify for lower rates. Lenders can invest small amounts of money in multiple loan packages to spread their risks and diversify their P2P portfolios.

How to Get Started

The first step is to register for an account with one or more peer-to-peer lending websites. Lending Club and Prosper are two of the most well-known networks, and both attract a wide range of borrowers. Even though P2P networks connent borrowers and lenders from all over the US, registration terms for lenders may vary by state, so read the fine print carefully. Do not falsify your residence information to get around state requirements, as you must report investment income on your state and federal taxes.

Signing up for an account is free, and once you have registered, you can search for individual loans, select loan packages, or sort the listings by various conditions. For example, you can restrict your search by loan purpose, credit scores abover or below a certain threshold, debt-to-income ratio, interest rate, loan term, and other parameters.

Building a Portfolio

P2P lending platforms have low minimum investment levels, so you can invest as much or as little as you like, in few or many borrowers. You can also sell P2P notes to other investors. As borrowers make payments on their loans, you can reinvest your earning or cash out. Because these are short term loans (3 years max), investors can see returns more quickly.

Understanding the Risks

Peer-to-peer lending networks can only pay investors when the borrower makes a payment on his or her loan. As with any unsecured loan, there is a risk that the borrower will default and the investor will lose most of his or her investment.

Be assured, however, that lending platforms report all delinquent borrowers, so a borrower who does not pay back a loan will suffer a drop in credit score and be contacted by a collection agency. Borrowers who default on P2P loans are not allowed to register new loans with P2P lending networks.

To minimize the total risk, investors should diversify their portfolios by taking on a variety of high-risk and low-risk loans.

© Had2Know 2010

How to Borrow Money from Peer-to-Peer Lending Networks

How to Calculate APY, aka Effective Annual Rate

Loan Comparison Calculator

How Can I Increase My Credit Card Debt?

What is the Maximum Interest Rate I Can Afford?

How Does the Bank Calculate My Monthly Payment?