Beginners Guide To Peer To Peer Lending
Welcome to my Beginners Guide to Peer To Peer Lending.
When I first started investing in peer to peer lending, the sheer number of platform choices was intimidating and overwhelming and the information available was limited.
Are you a complete peer to peer lending novice and have no idea where to begin? Read my Beginners Guide to Peer to Peer Lending and become a pro before you invest your first Pound.
TIP: Start Out Investing Through The Established Peer To Peer Lending Platforms
I continue to recommend the same platforms I started investing with. In the young peer to peer lending sector, look for companies with low default rates, competent default handling and longer trading histories.
I recommend starting slowly by investing in platforms that have established track records. Zopa withstood the 2008 economic downturn and Ratesetter is a profitable operation that has been delivering consistent returns since October 2010.
Ratesetter, Lending Works and Landbay offer easy peer to peer lending without having to spend too much time picking the investments. All three offer auto-reinvestent of interest and repaid capital which can be a huge time saver There are a multitude of platforms available for those wanting higher returns but I recommend investing in these once you become more experienced.
TIP: Diversify Across Multiple Platforms And Sectors
Some peer to peer lenders think investing in too many platforms is bad while other lenders think the opposite. I’m in the over diversification camp. I currently invest in between 15-20 platforms. This website allows me to document my experiences with many different platforms but even if I didn’t write this website, I would still use around 10 platforms.
I think of peer to investing like an index tracker stock market fund. Index funds are the ultimate diversification tool investing into thousands of stocks and bonds. If one stock or bond performs poorly, the index fund returns won’t be overly affected. If you invest in 10 peer to peer platforms equally and one fails, your returns won’t suffer as badly.
Also be sure to have a variety of different loan types. You don’t want to be 100% invested in property loans because if the property market crashes, all your loans could too.
Try to diversify across such sectors as property, jewellery, cars, airplanes, and personal loans.
TIP: Be Patient
Peer to peer lending takes time to learn. It can take several months to become fully invested and sometimes, lending demand will be much higher than loan supply. This can create a feeling of desperation and urgency to invest. This desperation can lead to poor loan selections resulting in lower returns and higher defaults.
Remember that there will always be new lending options so be patient and invest wisely. It took me six months to become fully invested.
Diversification takes time so don’t rush things.
TIP: Don’t Believe Everything You Read / Ignore The Noise
There are several forums that contain a myriad of information, some good information and some bad. But reading all the information can lead to jitters and impulsive decisions. Sometimes this information is factual, but sometimes it is purely opinions. In my early peer to peer lending days, I read some alarming articles about peer to peer lending and withdrew money from two platforms the next day. Upon further research, it turned oput these articles turned out to be nothing more than opinions and I ended up reinvesting within the same platforms two weeks later and have been with them ever since. This impulsive decision cost both time and loss of returns.
If you read an article that makes you nervous, do some research before making a decision as the information is not always accurate or true.
TIP: Make Adjustments As Needed
Going with my previous tip, some results can be an indicator of worsening future problems so don’t be afraid to make adjustments. For example, in September 2015 on of my platforms was experiencing mounting business loan defaults so I decided to sell most of my loan parts. A month later I thought I might have acted in haste so I gave the platform another try. It turned out I didn’t act hastily and experienced the same issues over the next three months. I sensed this platforms underwriting quality was low and that they might be issuing loans just to keep their lenders happy. At that point I decided to sell out of the platform for good even though it was one of my larger peer to peer lending holdings.
It is fine to make adjustments and move money between platforms. Loyalty won’t get your capital back if a peer to peer platform goes out of business due to poor management.
TIP: Don’t Be Afraid To Sit Out
Sometimes I read updates on loans that make me feel uneasy so I sell them on the secondary market. If there are no other available loans, I’m fine sitting on a cash balance until a new loan is released, even if it for several weeks.
I’d much rather not be invested than to be invested into a poor quality loan that has a high likelihood of default. Preservation of capital is always a good strategy.
TIP: Keep Checking For Changes
Don’t be surprised if a peer to peer lending platform suddenly changes their business model. For example, Funding Circle used to offer auctions where lenders would bid on interest rates on loans. It you were prepared to be an active bidder, 12% A-rated loans existed for the taking.
One day lenders received an email stating that Funding Circle would be eliminating their bidding system and switching to lower fixed interest rates. Interest rates proceeded to fall and I no longer felt the lower returns warranted the risk. I therefore sold all my loans and withdrew from the platform completely.
Another one of my past peer to peer investments, Fruitful, sent an out of the blue email stating they were shutting down their peer to peer lending business. They said investors capital would be paid back in stages, some amounts within a few weeks and other amounts within a year. I remember feeling quite anxious as I read that email, especially since Fruitful’s platform sold me on being “instant access”.
Expect to see major platform changes from time to time and don’t be afraid to make necessary adjustments.
TIP: Different Platforms Present Different Risks
On the surface, some peer to peer lending platforms make lending look somewhat risk free. One platforms front page ad currently reads “Earn 7.0% effortlessly”. Please understand peer to peer lending is risky. There is a reason why lenders are able to see returns of 4-16% while banks are offering 1%. With reward comes risk.
Platforms offering 12% returns can be much riskier that platforms offering 4% and that the 12% return prices in some of the extra risk. Also remember interest rate returns don’t always accurately represent risk. Funding Circle’s 8% unsecured loans may be more risky than some of Saving Stream’s 12% secured property loans.
While each platform has their own varying degree of risk, one thing remains constant; peer to peer lending is risky (ask Trustbuddy lenders).
TIP: Don’t Let Falling Interest Rates Affect Your Risk Tolerance
Since the Bank of England cut interest rates, savings account rates have fallen to miserable levels leaving savers scrambling for new investment opportunities.
Many savers are now considering investments they wouldn’t have considered 10 years ago. Their risk tolerance is climbing to dangerous levels in order to chase yields.
Many savers put large amounts of money into the stock markets in 1999 and 2007 when the markets were rising to historical levels. These same savers lost large amounts of money when they sold stocks after the markets dropped. Our risk risk tolerance can be swayed by economic conditions, so don’t fall prey to this mentality.
When considering a peer to peer investment, ask yourself if you would make the same investment if bank savings rates were 3 or 4%. If not then you should look elsewhere. Remember that peer to peer lending risk doesn’t fall when interest rates fall.
TIP: Defaults Are Inevitable
I can remember the horror I felt as I logged into my peer to peer lending account to see my first dreaded default notice. You will likely feel the same despair on your first default but don’t worry, defaults are a part of peer to peer lending. I don’t know of any lenders who have a 0% default record.
Remember that peer to peer lending is a long term investment and manageable default levels are part of the game. If you are finding your default numbers are high, you might need to adjust your platform or loan selections.
TIP: Don’t Put All Your Investment Eggs Into The Peer To Peer Basket
Occasionally I read about lenders who have put 50%+ of their savings into peer to peer lending. I think this is crazy. When I lost high six figures cash in property during 2008-2010, I learned the hard that diversification is key to long term investing success.
No matter how rosy the outlook, one change in the economic environment can bring an investment sector crashing down. Always remember this when deciding how much of your hard earned savings to invest in peer to peer lending.
When people ask me how much of their nest-egg they should invest in peer to peer lending, I answer, “How much can you afford to lose and continue to sleep at night?” My number is 13-15% but you have to decide what you are comfortable losing if the entire peer to peer market were to crash. Is it likely you would lose all of your money? No, but it is possible.
TIP: Ask The Platform Questions Before You Invest
As peer to peer lenders, we can be quick to transfer money to complete strangers / companies without knowing much about them. Don’t be afraid to call or email a peer to peer lending company and ask difficult questions. If you don’t ask and the platforms fails, you will be wishing you had.
Ask them such questions as:
What financial experience do the people in charge have? How are their business operations funded? How much future funding is available to them? Are they operating at a profitable level and if not, how long it will be until they are? Do they plan on making any major changes to their business model? How are lenders protected?
Also look at the company accounts on Companies House to view financial health.
Knowledge is power.
These are just a few tips for those of you looking to get your peer to peer lending feet wet. I also recommend reading my current Top 5 Peer to Peer Lending Sites guide and also reading the many unbiased peer to peer lending site reviews on Financial Thing.
** This beginners guide to peer to peer lending is for information purposes only and should not be regarded as investment advice. Opinions expressed in this guide are opinions based on my own personal experiences. As with any financial investment, peer to peer lending involves risks, so never invest more than you can afford to lose. **