Is Peer-to-Peer Lending a Good Investment Opportunity?

Peer-to-peer lending platforms have now been around for quite some time. With several years worth of results, some are still unsure of whether or not this unique form of lending is a good investment opportunity, or just another financial fad. In this article, we will attempt to explore peer-to-peer lending in terms of its legitimacy as a sound investment.

To begin with, we must briefly explore what peer-to-peer lending really is. In essence, it is a system that allows individual investors to make loans directly to those seeking funding for various reasons. This may seem unusual, but in reality, the money is put to the same basic use that it would be if kept in a bank savings account. However, since savings account interest rates have dropped to a national average of only about 0.06%, peer-to-peer lending holds a unique advantage for investors: interest paid on peer-to-peer loans goes almost entirely to the investors. In other words, the large amount of interest normally taken by a bank on loans can be realized by individual investors, making interest rates of 8-15% realistically attainable.

Some have criticized peer-to-peer lending platforms for being too risky to make for good investments. However, this is simply not the case. Just as any financial institution, peer-to-peer lending websites carefully screen those who wish to borrow through them. In order to even be considered for a loan, borrowers must meet basic credit standards. From there, those who are approved are grouped into various classes. Higher classes, those who are considered to be lower risk, are assigned lower interest rates. Lower classes, those considered to be a higher default risk, are assigned higher interest rates. This allows investors to pick and choose how risky they want their loans to be. Generally speaking, default rates are extremely low in higher categories, and not unacceptably high in the lower categories.

Given all of this information, is peer-to-peer lending a good investment? The short answer is yes. Given the high interest rates that can be paid at even low levels of risk, peer-to-peer lending beats out all but the riskiest stock portfolios for pure profit potential. The best strategy for managing risk and maximizing profits with peer-to-peer lending seems to be to invest mostly in low risk loans, with a few higher risk loans for diversity. This strategy guarantees a decent return on the lower risk loans, while still allowing investors to make larger profits on the handful of higher risk loans. Of course, peer-to-peer lending should be used to make up a part of a broader investment portfolio. It is, however, especially useful for those who are just getting into the world of investing due to its extreme simplicity. First time investors can easily begin investing amounts as low as $25 at a time and making respectable returns without the need for specialized market research.

For those interested in beginning to invest in peer-to peer-loans, there are two online platforms that are by far the largest. These two are Prosper and Lending Club, the latter of which recently went public with a very successful IPO. Both offer similar terms, interest rates, and protections, and either one is a good place to start. It can be beneficial to have an account on each, due to the fact that it gives prospective investors access to a wider range of loans to fund.