If you are just starting out with P2P lending you might ask yourself the question of how safe is peer-to-peer lending? I have had the exact same question when I started investing in P2P loans three years ago.
When it comes to the safety of your investment in P2P loans there are usually many questions connected to the risks with P2P lending. With this article, I will try to address all of those questions and give you a good idea about the risks with P2P lending.
I will share my experiences and reviews with various P2P lending platforms and the results of my extensive research about how safe peer-to-peer lending really is.
What is Peer-to-Peer lending?
Before we dive into the risks and securities of this asset class we need to understand the construct of P2P lending first. P2P lending offers investors like you and me the opportunity to invest in small amounts into different loan types.
Usually, you are funding personal loans, consumer loans, business loans or real estate loans. In return, you will receive returns in the form of interest.
In order to invest in P2P loans, you need to sign up on one of the platforms that connect loan originators or borrowers with investors. There are well over 100 P2P platforms worldwide and it’s not easy to distinguish which one is the right one for you.
I am active on several P2P platforms myself. Here you can read about my comparison of P2P platforms.
The advantage of P2P lending is that even small investors with little capital can invest and grow their capital. In the past investing was only available to venture investors and business angels. With the era of the internet and the help of P2P platforms, everyone can now become an investor. (This doesn’t mean that it’s for everyone though.)
Which P2P platform is safe to invest?
Nearly every week there are two to three new P2P platforms that try to get investors money to finance loans. Majority of them have no solid site, broken English (not that mine is perfect), no proper USP, and overall no functionality.
Here are a few hints on how to spot dodgy P2P platforms:
- No unique content but copied from another platform or website (just copy and paste it into Google)
- Very little information about the risks and functionality of the website
- No information about the company’s office or headquarters
- No team
- No or minimum equity (you can view this when you put the official name of the company into google and check the registry)
- The founder is not listed on the company’s page
It is also important to look at the design of the page. Often you can see yourself whether it’s a secure and well-made website or just a scam.
The age of the platform might be a fact to consider as well. Although it’s not a rule that young P2P platforms are not serious. You should definitely be more aware when transferring funds to a P2P platform with no track record.
You can also have a look at the P2P platforms social media to find out how much they engage with their audience.
Here are the facebook profiles of platforms I use myself:
Not every P2P lending platform is doing the best job on social media however it’s one thing that helps to gain trust in their services.
Something I like to do when there is a new P2P platform is to send them an email asking to provide a list of USP (unique features that give users more value than the competition), ask how they differentiate from the competition and why investors should invest on their platform. If I don’t get an answer or the email does not meet my expectations I usually don’t bother testing it.
You can ask some specific questions about:
- their buyback guarantee
- how is the loan secured
- explain their due diligence (what are they looking at when adding new loans / loan originators to the platform)
- requirements on the investors (residency, bank account, etc.,..)
You can certainly google more information about each P2P platform. Be, however, aware that many P2P blogs publish information without even testing the platform for the sake of getting a commission if you sign up through their link. I advise being aware of this when reading those P2P lending reviews.
Is P2P lending regulated?
Some investors think that the safety of a P2P platform is higher, when it’s regulated. Whether a P2P lending platform is regulated depends on the country where the platform is headquartered or where it is operating. For instance, in the UK, P2P lending platforms are regulated by the FCA (Financial Conduct Authority). Platforms outside the UK need to follow local laws and regulations as well.
It is however not a rule that P2P lending platforms are always controlled by regulators. It is up to every country to set up guidelines and oversee the operations of P2P platforms. Even platforms such as Mintos, Peerberry or EstateGuru who reside in Latvia or Estonia follow the local regulatory legislation. It is up to every platform to follow national guidelines and increase trust in their service.
You can read more about why Mintos did not receive a license from the FCA here.
How safe is P2P lending – Risks with P2P investing
P2P lending is not just about choosing the right platform but also knowing what risks are connected to your investments. P2P lending platforms do not guarantee any specific returns. You are solely responsible for your investment strategies. If you don’t diversify your investment properly you might lose it.
Here are four risks that I consider when investing in P2P loans.
Platform Risk – What happens when the platform goes bankrupt?
In most cases (not all the time), investor’s funds are separated from the operational capital of the P2P platforms, which means that the platform does not take the investor’s money to finance their operations. This is valid for funds that are not invested but stored on the investor account of the P2P platform.
In the event that a P2P platform is folding a third party will take over the administration of all loans and investments. In this case, it would be handled by a law firm which will distribute the payments to investors. This is the theory. As you can see even after months of closure of P2P lending scams, no one is yet taking over the distribution of the remaining funds.
The separated bank accounts is a typical procedure for P2P platforms that I invest in. How well this would work for newly launched platforms is questionable. If you want to read more about what will happen to your investment when a P2P lending platform goes bankrupt I suggest contacting the platforms directly or read through their FAQs. If the platform doesn’t reply to your message, it’s a red flag and a good indication that the P2P lending platform isn’t very safe.
Loan Originator Risk
Many P2P platforms that list consumer loans, work with loan originators from different countries. A great example is the P2P platform Mintos which lists loans from over 70 loan originators and 38 countries.
In the case that one loan originator becomes insolvent, the retrieval of investor’s money depends on the specific assignment agreement. If you for example invested on Mintos you have invested in loans with the direct and indirect agreement structure.
With the direct structure, you are buying claim rights against the borrower. If the loan originator goes out of business Mintos will take over the loan originators role.
With the indirect structure, you are buying claim rights against the loan originator. In the case of bankruptcy, Mintos has a commercial pledge with the loan originator which means that investors will be the first to receive money from the bankruptcy assets. Read more about this here.
In both cases, it might take months to retrieve money back and often it is not clear how much of your investment you will receive. In most cases, P2P platforms keep track of the loan originators finance reports to spot negative trends and safeguard investors money (in theory). In reality we have seen poor monitoring of loan originators on multiple platforms.
Be aware that not all of the P2P lending platforms do collaborate with loan originators. In that case, there is no risk with loan originators. Platforms such as EstateGuru or Crowdestor offer funding for real estate or business projects and do not list consumer loans. Some investors might get the impression that investing on P2P lending platforms that deal directly with the borrower might increase the safety of your P2P investments.
What happens if the borrower does not pay back? Do I lose my investment? That’s the key question most P2P investors are asking.
If you do it right you won’t lose your investment. How to do it right? That’s a good and tough question.
There are different loan types that you can invest in. Each loan type has a different borrower and therefore different securities.
While personal loans and payday loans are mostly unsecured loans, business loans are usually secured by commercial pledge, mortgage, and personal guarantees.
When I invest in unsecured personal loans I solely invest in P2P lending platforms that offer a buyback guarantee (not that this would increase the safety of my investments). This means that the loan originator will buy back my investment in case the borrower is late with its payments for more than 60 days. The buyback guarantee works well during normal market conditions. Many loan originators are suspending the buyback guarantee during an economical downturn. During normal market conditions the default risk is shifting from the investor back to the loan originator which will deal with the late payments. The investor will receive its money back and can reinvest it elsewhere. This does not always work, which is why the buyback guarantee should be perceived as a guarantee rather than a promise (which can be broken).
Investing in secured loans is in my opinion the way to go, if you are concerned about the safety of your P2P investments.
Skin in The Game
The loan originators are interested in retrieving the money back from the borrowers as they usually have their own skin in the game. This means that a loan originator invests 5% – 10% of each loan from their own capital. It’s therefore in the interest of the loan originator to retrieve the late payments.
Is P2P lending safe? Explaining the Buyback Guarantee
You should now have a rough idea of what a buyback guarantee is. There are however various forms of buyback guarantee which you should be aware of. Many investors use the buyback guarantee as a form of insurance that comes with P2P lending. Here is a short description of how the buyback guarantee works for platforms that I invest in.
The Mintos buyback guarantee is quite straight forward. Any loan that is late for more than 60 days will be sold back to the loan originator. Be aware that this is only valid if you invest loans with buyback guarantee.
As from my experience, the Mintos buyback guarantee has been working well for quite some time until some of the loan originators got suspended – then it didn’t work anymore. Investors should not, rely on this guarantee as in its roots it is only a promise from the loan originator and not a contract that forces the loan originator to fulfill this agreement by any legal means. Keep that in mind.
The buyback guarantee from Peerberry works exactly the same as with Mintos. Your investments will be sold back to the loan originator if the borrower is late with its payments for more than 60 days.
EstateGuru does not offer a buyback guarantee to its investors. However you do not invest in unsecured consumer loans but real estate loans secured by a personal guarantee, mortgage or mixed collateral. The loan is secured by a real value rather than a promise to pay back your investment.
In case, the loan defaults, there is still a property (land or real estate) that can be sold to return your investment. The maximum LTV (loan to value) on EstateGuru is 75% which means that borrowers need to pay 25% of the real estate value from their own pockets.
Crowdestor does not have a buyback guarantee as you are used from P2P lending platforms such as Mintos or Peerberry.
The platform is investing 1% – 2% into a buyback fund which should in case of a defaulted project cover a part of the loss. The buyback fund is currently a bit over €73.000 which in reality won’t cover too much as most of the projects funded on Crowdestor are worth well over €100.000.
When investing on Crowdestor you are funding secured loans in the real estate, energy, gaming or other industries. Even if one loan should default, there should be collateral that can be sold to cover for the loss.
The Crowdestor’s buyback fund is more of a symbolic manner to show that the platform has some additional safety mechanism in place.
The Robocash buyback guarantee kicks in after 30 days of borrower’s repayment delay. That’s half the time as compared to Mintos and Peerberry. If the borrower is late with its payments for more than 30 days the loan originator buys the investment back from you. The default risk, therefore, shifts to the loan originator as it’s the case with the Mintos and Peerberry buyback guarantee.
Market Risk – What happens when the recession kicks in
A question a lot of P2P investors are asking lately. Is my P2P lending portfolio safe when the financial crisis hits the market?
No one can predict the future, we can, however, look at the crisis in 2008 and how it affected P2P loans.
First, we should have a look at the performance of a P2P lending platform that was already on the market during the recession. Zopa was one of the first P2P platforms that started its operations in 2005 and only one who operated through the 2008 recession while delivering stable positive returns!
While Zopa could not meet the expected annual returns of around 7% it could still remain positive with returns of 4% – 5% during 2008.
In this graphic, we can get a good example of how the UK based P2P lending platform Zopa performed compared to a different asset class (FTSE 100 index) back in 2008.
The graphic is a good indicator that P2P lending does not correlate with the stock market.
Continue reading to find out why!
Read more about the performance of the P2P platform Zopa during recession here.
The asset class P2P lending can be compared to credit cards. Most of the P2P lending platforms finance consumer loans which credit cards do as well.
Even though there isn’t a lot of data on P2P performance from the last recession, we have plenty of data about credit card performance for the past two decades.
On this graph from the United States Federal Reserve, you can see the interest rate mirroring the default rate of credit card loans. As you can see there is a significant increase in defaulted loans during recession however there was always a spread of a few percents which led to the outcome that banks never had a single negative year and remained profitable even during the recession.
With similar interest rates in the peer-to-peer segment, we can expect to still make profits even during the recession when the stock market plummets. There is an interesting article published on TechCrunch that expands on this topic. You can read it here.
Bottom line is that you can expect a decrease of interest earned from P2P investments during a recession. This can, however, happen also when there is an uneven ratio between the demand and supply of investment opportunities. It has happend before that the amount of investors was bigger than the amount of loans on a single platform, which ultimately drives down the interest and limits certain features of the P2P lending site. For example on Mintos, the auto invest stoped working as it didn’t match investor’s criteria regarding the interest rates.
What about P2P lending in the real estate niche?
P2P loans that are financing developing projects in the real estate segment cannot be compared with unsecured personal loans. In this case, the loans are secured by a real asset. A total default of the loan is therefore very unlikely as collateral, personal guarantees and mortgages will cover the loss.
Increase the safety of your P2P investments – strategy is what matters
P2P lending can be very risky but it can also bring a lot of opportunity for capital gains. It all comes down to the investor’s risk profile and its investment strategy.
You can lower the risk with the following strategy:
- Invest in secured loans
- Invest on trustworthy legit platforms
- Choose a short investment period or use tools such as Invest & Access from Mintos
- Invest in loans from loan originators with good financial outcomes
- Diversify your portfolio across loan types, loan originators and countries
Many investors don’t invest in P2P loans because of their fear of long capital commitment. This isn’t a valid argument anymore. With platforms such as Peerberry or Mintos, you can access your money within days or weeks, depending on your investment strategy. You don’t need to lock your capital for years to get a positive return.
Although short term investing isn’t something I would lean towards for the long run, it can certainly serve a purpose within your short-term investment strategy. Even with P2P loans, you have the possibility to react to market changes very fast. If you see an opportunity in the stock market, it won’t take long to shift money from your P2P portfolio towards stocks or any other asset classes.
I hope you found this article about the risks and securities of P2P loans helpful. For many new investors, this can be quite confusing to figuring out whether peer-to-peer lending is safe. Understanding P2P investing is not hard, it only takes a bit of time.
If you have any questions about the safety of P2P lending or want to share your thoughts, feel free to comment below.
This article is meant to expand your knowledge about P2P lending. If you decide to use it and invest in P2P loans you are solely responsible for your actions.