Peer to peer lending has become very popular among yield-seeking investors because traditional investments continue to disappoint. Investors can even earn 7% to 11% returns by investing in unsecured p2p loans. But if you are thinking of investing your money in p2p loans, you should look beyond the interest rates. Like other financial products, p2p lending also has some risks that you should consider before deciding. Here in this article, we are going to describe how safe p2p lending is, its regulations and the safest platforms for investment.
What Are P2p Lending Risks?
The most significant risk in p2p investment is that the person who borrows money may make late repayments or default on a loan. The chances and consequences of borrowers defaulting may vary from platform to platform.
Another risk associated with p2p lending is that the money you invest is not protected by the Financial Services Compensation Scheme (FSCS). It means that you can not make a claim for a refund of your money if a borrower defaults or the p2p platform experiences financial distress. However, all the p2p platforms have rules and plan to protect lenders from the risk of losing money. You can also take steps such as diversification to reduce these risks.
Most of the p2p platforms offer unsecured loans, which means borrowers do not need to use any of their assets as a security against the loan. So unsecured loans have more chances of defaults. So there are chances that you might lose all of your money on an early term default. That is why diversification is essential to reduce the risk of loading all the capital.
If you want to invest your money for a short time, you should cautiously select the loan terms. It is difficult to withdraw money before the loan terms end. Some p2p platforms have a secondary market where you can sell loans before the loan terms end, but you have to pay charges to sell loans that can eat your profit.
Peer To Peer Lending Regulations
In the beginning, there were no regulations of Bridging Loan platforms, but now all the platforms in the UK are regulated by the Financial Conduct Authority (FCA). It ensures transparency and fairness in the p2p lending industry. You can search on the
FCA register to find whether the p2p platform is regulated or not. There are several rules that p2p platforms need to follow. Some of them are as follows:
● The platforms have to place the funds of lenders in ring-fenced accounts so that they can be returned if a platform goes out of business.
● The platform must give 14 days right to the withdrawal period. During this time, lenders can end their agreement due to any reason.
● According to FCA, platforms should comply with the capital requirements to ensure that they are resilient if there is any financial difficulty.
If you do research and invest your money through a p2p lending platform that the FCA authorised, you can reduce the chances of risks and get transparent service.
Characteristics Of Safest P2p Platforms
The safest peer to peer lending platforms follow best lending practices and use several techniques to protect investors and make sure that they receive the expected returns.
Strict Underwriting
The more strict your p2p platform is in lending money, the less the chances of borrower defaults will be. However, you must keep in mind that the risk can not be eliminated completely, as even the borrowers who have good credit scores can fail to repay the loan due to a sudden financial crisis.
The leading p2p platforms carry out credit checks, affordability checks, fraud checks and identity checks to ensure that the investor’s money is lent to creditworthy borrowers, and in this way, the chances of defaults are also reduced.
Diversification
It can never be a good idea to put all the eggs in the same basket. Diversification is the rule of every investment and is a key to mitigating the risks. In p2p lending, diversification means spreading your investment across multiple loans. It helps you to reduce the risk of default, and if one of the borrowers default, you can continue to get profit from the other loans.
It may be difficult for you to read the risk profile of every borrower and select the best ones. Most p2p platforms now offer auto investment functions that help lenders in managing the portfolio and save time. You only need to set your lending criteria and deposit fonts. The platform automatically spreads your investment across multiple borrowers and helps you create a diversified portfolio.
Contingency Fund
Although FSCS does not protect your investment in p2p loans, many platforms offer contingency funds to protect investors in case of borrower defaults. This contingency fund covers a certain amount of money lost through defaults or delayed through arrears. Some p2p lending platforms cover all the defaults and arrears, which means all the investors on such platforms always receive expected interest on time. So you should always invest your money in a platform that offers contingency funds to reduce the risk of losing money.
Backup Service Provider
Backup service providers are those who take the responsibility of managing, servicing and collecting funds in case your p2p lending platform ceases. Otherwise, there are chances of losing all the investment if the platform busts, as there is no protection by the FSCS. Therefore, good p2p platforms have third party backup service providers to provide maximum protection to the lenders.
Now that you know the risks associated with peer to peer lending, you can understand easily how safe this type of investment is. Along with several p2p lending, there are some risks too. But if you choose the right platform and take measures to reduce risks, you can even earn double-digit returns. If you compare p2p lending with other investments, you can see that these investments offer below-inflation interest rates, and you may lose your savings over time. Nevertheless, the attractive returns make peer to peer lending a sensible way to grow your money.
