How P2P Lending is Revolutionizing Investing

Facilitating direct connections between borrowers and lenders, peer to peer (P2P) lending has ushered in new investment opportunities. Eliminating traditional financial institutions from P2P lending gives investors an opportunity to employ it as a means of portfolio diversification. This is how P2P lending is revolutionizing investing—alongside asset-based alternative investments such as those offered by Yieldstreet.

How P2P Lending Works

P2P connects borrowers with investors who provide loans. These pairings are typically accomplished using P2P lending platforms that have emerged to process these transactions. 

Borrowers can get interest rates starting at approximately 4.60%, according to Forbes.com. Loan terms average three to five years, which makes them attractive to investors preferring shorter time horizons. Investors choose the types of loans they would like to fund when they register with platforms. They also have the option of partially funding loan requests, which can be a good strategy, as it limits an investor’s exposure to any single borrower. 

Borrowers are ranked according to their credit histories—the primary elements of which are their FICO scores and debt-to-income ratios. Loan amounts, stated purposes of the loans and terms requested also figure into borrowers’ rankings. Applicants whose FICO scores are below 600 are usually declined. Applications from potential borrowers with recent bankruptcies, judgments or tax liens are also typically refused. 

P2P platforms also perform loan underwriting and closing, as well as loan distributions and lender payments. They generally take a 1% fee for providing these services. 

The Benefits of P2P Investments

P2P lending offers investors comparatively short time horizons, potentially high returns, the prospect of monthly passive income and a low entry threshold. Investors can get started in P2P lending with as little as $10.00—without the requirement of becoming an accredited investor. 

They can also set the parameters within which they prefer to lend, prescribing terms, credit score ranges and debt-to-income ratios of individuals with whom they are willing to engage. 

Carefully crafted P2P portfolios have the potential to return 10% or better on an annual basis. Proceeds can also be deposited directly into both standard and Roth IRA accounts, taking advantage of the tax benefits those investment vehicles present. 

Potential Downsides

Because most P2P loans are unsecured, the risk of borrower default is always present. Further, unlike bank deposits, money invested with a P2P platform will be forfeited if the platform fails. The FDIC does not offer coverage in these instances, nor will it step in if a borrower fails to repay their loan. 

Further, these investments can lack liquidity, as they usually cannot be sold on the secondary market. There is also the risk of capital depletion, as principal repayment and interest payments are made simultaneously. P2P investors must separate interest returns from principal to preserve their investment capital—or reinvest both to potentially compound their earnings.

Investors considering P2P as a means of portfolio diversification can learn more about this, as well as about asset-based alternative investing, at Yieldstreet.com.