Updated January 11, 2020

Investing With Peer-to-Peer Lending – The Ultimate Getting Started Guide

Passive Income Ideas

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Peer-to-peer lending investing is a great way to grow your money outside of traditional brokerage accounts. This type of investment takes banks out of the equation by connecting individual investors like you with borrowers who need money.

Peer-to-peer lending through sites such as LendingClub is a win-win situation for all involved. Borrowers get access to much-needed funds quicker than they would with traditional lenders. And although there’s still risk involved, as an individual lender, you may even get a better return on your investment compared to traditional brokerage accounts.

Intrigued? We thought you might be.

Read on for a breakdown of peer-to-peer lending, who it’s best for, and where to start investing.

What Is Peer-to-Peer Lending Investing?

Also known as P2P lending, peer-to-peer lending is when individual borrowers and investors come together on an online platform to either receive or fund loans.

Both borrowers and lenders save money on administrative fees while earning competitive rates. In other words, lenders can get a high rate of return on their investment and borrowers can borrow money at a lower rate compared to a big bank.

Peer-to-Peer Lending for Borrowers

Borrowers seeking P2P lending will fill out an application form on their desired platform. Typically, there’s a brief assessment to determine the borrower’s risk profile, and a credit check is conducted.

Once that’s complete, borrowers receive an interest rate quote. If the borrower agrees to the rate, the application moves on to the funding stage, where investors will review the loan listing and decide whether to fund the loan.

Funded loans on a P2P lending platform move on to the underwriting process to finalize the application. If approved, funds are then transferred to the borrower and the loan enters the repayment stage.

Investing Through Peer-to-Peer Lending

After registering with a platform, lenders see a list of borrowers who need their loans funded. Each loan applicant is assigned a loan grade, which is a way of determining a borrower’s risk profile.

The lower the loan grade, the riskier your investment could be. The borrower may have bad credit or a history of not paying back their loans on time. However, keep in mind that the higher the risk, the more you may earn back in interest.

Loan amounts are typically anywhere from $2,000 to $40,000, although there are peer-to-peer lending platforms that fund loans upward of six figures. LendingClub, for example, funds business loans up to $300,000.

But that’s not to say that you need to lend money to only one borrower.

Those who are interested in investing in peer-to-peer lending can fund loans starting in $25 increments. That way, you can spread out your money across different borrowers so your investment is diversified.

Once the funding period is over and the borrower’s loan is approved, you’ll fund the amount agreed upon.

The loan then moves on to the repayment stage. As borrowers make regular payments throughout the life of their loans, you’ll receive your share of their payments in both interest and principal.

Peer-to-peer lending platforms may charge fees to lenders and borrowers. Make sure you review all terms and conditions on a platform’s website before investing. LendingClub, for example, charges a service fee that’s about 1% of borrowers’ payments.

Read our full LendingClub review here.

Common Types of Peer-to-Peer Loans

Not all P2P lending platforms are the same. Some websites specialize in one or two types of loans.

As a lender, you may not care about the type of loans offered, but this could affect the types of borrowers and risk profiles you’ll find.

Here are some common types of P2P loans:

  • Mortgages (including a second mortgage, like a refinance)
  • Auto loans
  • Student loans and student loan refinancing
  • Personal loans (including loans for high-interest debt consolidation)
  • Medical loans
  • Business loans

The Pros of Peer-to-Peer Lending

One of the biggest advantages of peer-to-peer lending investing is the potential for attractive investment returns.

For example, “safer” investments like CDs and high-interest savings accounts don’t offer high returns on your investment. In fact, the national average for a one-year CD is less than 1% APY as of this writing. P2P lending provides investors with competitive returns per year, if they’re spreading their money throughout multiple loans.

When investing in P2P lending, you know exactly to whom your money is going and that your investment is making a difference in people’s lives. If you’re able to lend money to someone who is paying down their medical debt, for instance, it might feel good knowing that you’re helping their financial situation.

The Cons of Peer-to-Peer Lending

As with any type of investment, you could lose the money you invested. There is a real risk that borrowers might not pay back their loan and therefore go into default.

Assess each borrower and make a decision whether to lend to that individual based on the criteria you set. Remember, a lower loan grade means a higher risk for your investment (and a greater chance you might lose your money). Note that, as we describe below, the major P2P lending platforms do allow you to automate your investing rather than selecting loans one-by-one, if you so choose.

Of course, there’s no right or wrong answer on how to approach this, but if you prefer being a more hands-off investor, you may not want to go this route.

It takes a diverse portfolio to get competitive returns through peer-to-peer investing. It’s also a long-term game, so being patient with the process is key.

Peer-to-Peer Lending Investing Companies

Considering there are so many P2P lending platforms out there, which one should you pick? Here are some popular options to consider.

LendingClub

LendingClub

Founded in 2007, LendingClub is one of the most widely known peer-to-peer online lending platforms. By the end of Q4 2018, LendingClub had issued over $44 billion in loans.

The company offers an online platform where you can complete the entire lending process in as little as a few minutes. Once you create an investor account online, choosing loans to fund is straightforward.

Your investments are called “notes.” You can find out the risk profile of each note borrower. After transferring a minimum $1,000 investment to start, you can invest as little as $25 across a variety of notes.

LendingClub lets you automate some of the process by picking your desired strategy. The platform offers a “Platform Mix,” which spreads your investment across all note grades. You also can choose your own custom mix of notes or pick your investments manually.

Each note has a grade from A to E that’s based on LendingClub’s own assessment of a borrower’s credit risk. The lower the grade, the higher the rate of return and the higher the risk of default.

Lending Club Grades

According to LendingClub, average historical returns range anywhere from 3% to 8%.

If you’re just getting started, LendingClub has a comprehensive education section where you can learn more about how to start P2P investing through the platform.

Read our full LendingClub review here.

Prosper

Prosper

Started in 2005, Prosper is another large P2P lending marketplace. To date, Prosper has funded over $14 billion in loans to more than 900,000 borrowers.

When investing through Prosper, you have a few options to choose from over seven risk categories. The level of risk you can take on ranges from AA (lowest risk) to HR (highest risk).

Prosper Grades

Prosper’s historical returns are somewhat similar to LendingClub’s.

You can get started with as little as $25 per investment and spread your risk across different categories. Instead of manually picking loans, you can have Prosper automatically invest for you.

Funding Circle

Funding Circle

Funding Circle is a peer-to-peer lending platform that makes loans to small businesses. Its mission is to help small business owners grow.

The company has helped thousands of small businesses grow through 88,000 investors across the world. These numbers look small, but that’s because you need a more substantial amount of money to lend to these small businesses.

A minimum of $250,000 is required to start investing with Funding Circle. That’s a lot for most investors, but if you can afford it, you can reap great returns.

According to Funding Circle, you’ll be able to invest in established U.S. small businesses with positive cash flow and sound strategies for growth.

How to Get Started in Peer-to-Peer Lending Investing

If you’ve decided on a P2P platform and feel comfortable with the required minimum investment, fees, and potential returns, it’s time to register for an account.

Let’s say you’re opening an investing account with LendingClub.

Lending Club Signup

Getting started is relatively straightforward with a four-step process that includes:

  1. Creating your account
  2. Verifying your identity
  3. Funding your account
  4. Choosing an investment strategy

When choosing a strategy, you certainly can have LendingClub automate your investments for you. However, you’ll still want to assess your own risk profile before doing so.

If you want to pick loans manually, consider creating criteria for doing so. For example, decide if you’ll lend only to people who have paid off a loan successfully before, or if you’d rather limit how much you loan out to high-risk investors.

Even if you pick a strategy, you can always switch it up. Feel free to log into the platform to see how your investments are doing, learn from them, and change tactics if needed.

The Bottom Line

Investing in peer-to-peer lending offers a unique way for people to invest outside of traditional investment vehicles. But it can also be more risky, depending on the borrower risk profiles you lend to.

Remember, it’s important to do research to see if peer-to-peer lending through LendingClub, Prosper, or another platform is the right choice for you. If you want to add diversification to your portfolio, you may want to open accounts with more than one peer-to-peer lending platform.

As long as you are aware of the risks involved and create a focused strategy, it might be worth taking the plunge.

Logan Allec, CPA

Logan is a CPA, Certified Student Loan Professional, and founder of Money Done Right, which he launched in July 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.

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