In peer-to-peer (P2P) lending, a person lends money to another person or business. It works in the total opposite way of the traditional money lending process. Normally, when people need a huge amount of money, they will lend from a bank or a financial company. P2P will become the middleman that connects people who are willing to borrow with people who need money.
Like any other investment, P2P lending has pros and cons. Let’s start with the benefits of P2P investment:
1) Substantial return – P2P investors can gain potential and predictable return of investment (ROI) when borrowers pay back their loans every month. This will be their consistent passive income.
2) Low entry barrier – By comparison to other investment methods, P2P is the preferred choice of many new investors, because it only requires minimal capital to begin with, and it only charges you a one-time cost.
3) Higher return – A well planned portfolio can let investors earn significant returns, with annual return more than 8%. This is a great opportunity for diversify your portfolio but at the same time gain benefits from it.
4) Evaluate risk – Investors can choose the level of risk that they will be facing, which means they can choose to lend their money to higher or lower rated borrowers. Of course, the higher the risk, the greater the return will be. Investors can also choose to spread the risk among different borrowers.
5) Set rules – Not only risks are under control, but investors can also set the type of loan to fund, debt to income ratio, return duration of borrowers based on their preferences. After determining these guidelines, investors no longer have to worry and only wait for their returns in the meantime.
On the other hand, the disadvantages of P2P lending are stated as below:
1) High Possibility of Default – If the borrower defaults, the investment will be gone, this will happen in the beginning of the loan because P2P does not require the borrower to submit collateral nor are investors being protected by banks or credit unions. Thus, the investor might experience capital loss.
2) Lack Protection – P2P lending is highly dependent on the current internet technology to link investors (money lenders) and borrowers. Users of the P2P platform will face problems such as fraud losses if there is a network failure, website breakdown or if the borrower defaults. P2P investors are not protected by any financial laws.
3) Costly managing fees – Most P2P platforms will charge investors around 1% of capital to handle all the loans. On top of that, investors may need to offer a rebate in order to attract borrowers.
4) Lack of liquidity – In P2P, the money of investors will be held until the loan is fully repaid. The investor can’t withdraw their investment during that time frame because most traditional P2P platforms would not allow investors to do that.