Many investors are familiar with investing in corporate and government debt through the purchase of bonds. Bonds are often attractive because they’re considered one of the safer types of investments. This is especially true of U.S. Treasury bonds which are guaranteed by the U.S. government. Did you know that you can also invest in consumer debt?
The big banks make billions of dollars in the interest and fees from consumer borrowing. As of November 2011, consumers hold $2.5 trillion in debt and they’re paying interest on that debt month after month. The debt would be even higher, except there are some consumers who can’t or won’t borrow from big banks, either because they don’t meet the bank’s qualifications or possibly because they don’t like banks. Therein lies the opportunity for you to capitalize on consumer borrowing.
Peer-to-peer lending isn’t a new concept. People have been loaning money to each other for centuries. But, sites like Prosper.com and LendingClub.com have made it easier for borrowers to find loans and for people like you and me to fund these loans.
As with a bank loan, borrowers go through a qualification process to get a peer-to-peer loan.
With Prosper, borrowers are given a rating, AA, A, B, C, D, E, or HR, which indicates their default risk. Loan rates are assigned based on the borrower’s rating. A rating of AA is the best carries the lowest interest rate, while HR is the worst rating, indicating a high risk and currently carries the highest interest rate.
Lending Club, another major player in the Peer-to-Peer (or P2P) lending space, has a similar rating system with ratings from A through G, where A is best and G is worst. Lending Club boasts an average borrower FICO score of 715 (which is very close to excellent) and almost $70,000 personal income.
When you lend money through a P2P network, borrowers pay you back, with interest of course. You can choose loans individually by scrolling through each borrower looking for a loan, or you can allow the network to invest for you after selecting your investment criteria. The P2P network takes a small cut of the interest and you keep the rest. The lending risk is spread among many different lenders, so you don’t have to take on the risk of a $20,000 loan unless you want to.
From a lender perspective, higher interest rates mean higher returns. However, borrowers with higher rates also have a higher risk of default. You can lessen the impact of a default by spreading your investment among several different loans. Instead of investing $100 in 10 different loans, you can invest $25 in 40 different loans. That way, if one borrower defaults, you’ve only lost $25 instead of $100.
You may not be able to pursue a borrower who defaults on a loan. And there’s double the risk of not getting paid – both from borrower default and P2P network failure. The former is much more likely than the latter.
Returns seem to be attractive, with several blogs and media outlets reporting an average 10% return. According to Daily Finance, Curtis Arnold of CardRatings.com earns 11% to 13% on his P2P loans. Another lender, Greg Collett says his returns are around 14%. Of course, these rates aren’t guaranteed. Don’t immediately lend out your entire retirement savings. Instead, start small. Get familiar with the lending system and then work your way up to a larger investment after you’ve found what works for you.
Picture by FreeDigitalPhotos.net.
The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
In accordance with FTC guidelines, we disclose that we have a financial relationship with companies mentioned in this website. This may include receiving access to free products and services for product and service reviews and giveaways.
Any references to third party products, rates, or websites are subject to change without notice. We do our best to maintain current information, but due to the rapidly changing environment, some information may have changed since it was published. Please do the appropriate research before participating in any third party offers.