Best Peer to Peer Lending Sites for Investors
As an investor, these 3 sites are the big players in the P2P lending space, where you can help out people who need a loan and earn a respectable rate of return as well.
Peer to peer investing is a promising investment vehicle that is showing major industry growth. If you’re interested in P2P investing, we compare the top peer to peer lending companies below that allow individual investors to sign up.
Peer to peer lending (P2P lending), while not completely new, is still considered a new kid on the block when it comes to investment vehicles. Perhaps because it’s still relatively new, that would explain why some people fear it.
Furthermore, the first peer to peer lending platforms came onto the scene around 2006 and 2007 - talk about bad timing! When the recession hit shortly thereafter, these platforms experienced up to 30 percent default rates. This added fuel to the already “It’s new so it’s very risky” fire.
Fortunately, we got to sit down with Joseph Hogue of Peer Finance 101 to help us dispel myths, explain how peer to peer lending works, and let us know why he thinks P2P investments are going to become mainstream in a few years. We even got him to share how much he’s making and the criteria he uses to invest in P2P loans.
What is Peer Lending?
In its most basic form, investing as a peer to peer lender means loaning money to a creditworthy borrower through a platform like Lending Club or Prosper. The platform does all of the credit and background checks for you to pre-qualify personal loan candidates; all the loans are then presented to investors like yourself, and you decide which loans to invest in.
Peer to peer lending isn’t much different than what banks do when giving loans. When a bank does this, they gather all the loans and give them to an investment firm. The firm then breaks it up and investors can buy whichever loans they choose.
The only real difference is there is no middle man involved. In the case of peer to peer lending, there is no bank and there is no investment firm. Instead, it puts investors directly in contact with the borrower, hence the name peer to peer lending.
The industry is currently flourishing with $25 billion a year already being invested in peer loans. It has provided an alternative for borrowers who may not be able to qualify for a bank loan due to tighter restrictions. It also provides a vehicle for investors that balances risk and reward because you can choose to lend to people who more likely to pay off loans.
According to Hogue, the market is also ready and waiting for such a disruptive force in finance. “Bank loans to small businesses are low and student loans are high,” he says. People are trying to either find ways to fund their business or refinance their debt, and the traditional avenues aren’t really helping. Hogue confidently adds, “With the way things are going peer lending will become a traditional form of lending in a few years.”
Most interesting about this phenomenon is the fact that most of us are already investing in peer lending but just don’t know it. According to Hogue, large institutions like insurance companies and endowment funds are participating in peer to peer investing. Meaning, if you’re paying insurance premiums, some of that money is likely being used to invest through peer to peer lending sites - you’re just not seeing any of the return.
How much money can you actually make?
Loans in peer lending platforms are usually offered in three to five year terms with a fixed interest rate. The platforms usually charge 1% to investors. The average return rate is 8% ranging from 5% to 9.5% depending on risk factors. After the term of the loan you can cash out or use the proceeds to reinvest.
“Peer lending can actually make a loan at 4% cheaper than a bank can,” says Hogue. “Just the costs of running a physical branch can cost banks 35 percent of their total operating costs.”
Additionally, because you have so much control over the loans you choose to invest in, you can create a strategy that works for you.
“I’ve made a 10% return in about two years,” says Hogue. “My cousin, who’s been investing in peer lending for 6 years, is averaging a 12% return. It’s just as safe as investing in corporate or government bonds, but those only average a 3 to 4% return.”
You can actually get an entire picture of how peer loans on the Lending Club Platform are performing here.
What about defaults?
You’re probably thinking, “That’s great and all, but what about defaults? What happens if people don’t pay back the loan?” We’ve got an answer for you.
First, as with any investment vehicle (or anything period, really) there is risk involved. Defaults are going to happen just like the stock market has down days. In the case of peer lending, there’s a 20% default rate on average. This means two out of every 100 loans may default. The key is to be smart about it by diversifying so a single default doesn't have too much of an effect on your returns.
“Even if the borrower looks perfect on paper, there’s still a 2% chance they will default,” says Hogue. “Your best bet is to invest in multiple loans - maybe somewhere between 100 and 200 for as little as $25 a piece - to account for those instances when defaults happen.”
As an added bonus, about 8% of the defaults go to a collection agency, which on average are able to retrieve 20% to 30% of the loan value back, which means the investor will still see some of that money.
What is the best criteria for choosing which loans to invest in?
What’s cool about peer to peer lending is you can see everything about a potential borrower before investing. You can see their credit score (the average FICO for Lending Club is 700+), their occupation, how much money they make (average for Lending Club is $74,000) and more.
The platforms offer about 40 different criteria but Hogue says you really only need about 5 to 10 total. Here’s what Hogue himself looks for when deciding which loans to invest in:
- Home ownership. This shows stability.
- Debt to income ratio of less than 20%
- No credit inquiries in the last six months.
- Stable occupation. For example, Hogue tries to find borrowers who work in education or the government because they are pretty protected.
- Income of $50k or higher.
In other words, Hogue looks for great borrowers that may have been turned down by banks because of increasingly strict standards.
Hogue also uses a combination of do-it-yourself underwriting in conjunction with the platform’s lending robot. “I’ve got about 60% to 70% being automatically invested and manage about 25% on my own” he says.
He admits he doesn’t see much of a difference between the two because the robots are meant to find loans based on your criteria anyway. “I just like to manage some of my own investments for fun,” he chuckles.
Peer to peer investing is a promising investment vehicle that is showing major industry growth. Many investors like Hogue have already seen returns and major corporations and banks are investing in it as well. It may have gotten off to a rocky start, but it’s definitely making a comeback and providing alternate forms of borrowing and investing.