Playbook #020: Peer-to-Peer (P2P) Lending
🖼️ The Big Picture
Just like Napster cut out the middle man in the music industry with peer-to-peer file sharing, allowing listeners to share songs with each other for free, peer-to-peer lending disrupts the traditional lending model by cutting out the banks, and allowing investors and borrowers to connect directly with each other.
Investors can build a portfolio of loans with different risk ratings. For instance, if you have $25,000 to invest, you could have 50 different loans of $500 each, some paying 3%, others 6%, and some at 10%.
Borrowers can typically get lower rates than with the banks, and those with lower credit scores will find it more accessible. They can get unsecured loans, typically up to $35,000, and use them for debt consolidation, personal reasons like medical bills, for education purposes, in real estate, or to start or grow a business.
Borrowers have to apply and are vetted like any other type of loan, based on credit score, work history, income, etc. As an investor, you can choose to fund some, or all of the loan depending on how you want to diversify your portfolio.
If you loan money out to consumers (for consolidating debt, financing a big purchase, etc) you can get higher interest rates, but will also have a higher default rate. Most platforms will grade each loan based on the likelihood it will get repaid (see below for details).
Asset-back P2P lending can offer a greater chance of risk mitigation, but may pay lower interest rates.
A well-known phrase in the world of peer-to-peer lending is this: "lending is only lending when you get the money back." So you always want to remember that defaults are a part of risks involved, and use proven strategies to mitigate those risks.