Investors are constantly looking to make the best possible deal with their money. Banks and other common financing options are going out of style. Right now, the alternative finance market is booming and it’s hardly considered a surprise. Financing options such as peer to peer lending are catching on and investors are looking into them to add value to their investments. Here are some of the main advantages and disadvantages that come with investing in peer to peer lending.
They have sensible return rates
The past few years have shown that traditional investments which are considered "safe" don't perform as well as they used to. Savings accounts and cash ISA accounts aren't providing the interest rates that they used to, and the profits are barely a tick above inflation. Given enough time, the savings lose their spending power and the investment isn't as effective as it could be. This is part of the reason that investors are turning to alternatives like peer to peer lending to improve their portfolio.
One of the premier advantages of these kinds of lending systems is that they provide quick returns that are well-above rates of inflation. Even though inflation is somewhat unstable and unpredictable, you can expect peer to peer investments to match it at the very least, while mostly being above the average rate. It’s an alternative investment that is slowly proving itself to be very lucrative. You can use it to boost your investment portfolio without creating any significant risks.
There are FCA regulations involved
A big part of why people are sceptical of peer to peer lending is because it seems like a wildcard option. If transactions are made between two peers without government regulation, how likely is it that the transaction will be fraudulent or unprotected? Very unlikely, since it is actually regulated by certain agencies like the FCA.
The FCA or Financial Conduct Authority provides these services with a framework that has to be followed for fair and transparent services. The financial sector is kept in check so that these loans are made with honest intentions and are paid off properly. Even if you're new to the sector, you can be sure that the FCA helps protect from fraudulent transactions.
This is achieved by increasing the transparency within these deals. Lenders and customers are given all the necessary information they need to make a well-informed decision on their investment. Before investing in peer to peer lending, you will be given all the guidance you need to avoid making an unnecessary mistake.
Lending money can be risky
Peer to peer lending isn't as well protected as lending money through banking. Your money isn't covered by the Financial Services Compensation Scheme, which means you shouldn't necessarily expect a payout in the event that something goes wrong. However, the deal isn't just made between you and the person you're doing business with. There's a third party you need to consider: the peer to peer lending platform you use.
These platforms often have their own terms of service that determine what happens before, during, and after a transaction. Considering that they get a small cut, it’s understandable that they will want their users to feel safe investing their money through the platform. They should be able to tell you whether or not your money is protected in the event of a default or other kind of issue.
Because of this, it’s crucial that you choose your lending platform wisely. It can mean the difference between a safe investment and a loss of thousands of dollars. Check reviews online for people that have had similar experiences with these platforms and use them to get closer to finding the right one.
Peer to peer can be time-consuming
Having a lot of choices is one of the great benefits of peer to peer lending. You can’t obtain as much of a diverse portfolio investing in regular loan options as you can with peer to peer.
However, this benefit is also a downside in many ways. While it’s true that you can invest in a variety of options, these take time to set up. If you decide to invest with hundreds of different “peers”, you’re going to have your hands full for quite a while.
Managing a diverse portfolio means interacting with a lot of investors and lenders. Since it’s often done with small amounts at first, you’re going to have to organize your investments in a very efficient way to keep track of all of them.
This is why many investors use managed direct lending platforms to get a head start for all that work. It's a lot easier than just doing everything on your own. Alternatively, there are also lots of platforms that offer "fund and forget" models where you invest in peer to peer lending and then allow investment teams to do the job for you. It might cost you a fee, a lot of people see it as a worthy investment that helps save them time and effort.
Some time might pass before an offer is made
Once you invest your funds into a peer to peer lending service, you need to wait before an offer is made for it. You are the one that sets the terms for the loan, which means you have full control of how the borrowing process will continue. This is great for avoiding a bad deal, but it can filter out a lot of potential borrowers. You need to wait until the platform finds people that are willing to agree with your terms.
It might be a while before you get borrowers to invest in. On the other hand, this depends entirely on you and your investment. It’s just as likely that you’ll see instantaneous results the first day that you sign up, as long as you present a good deal.
Peer to peer platforms use algorithms to match borrowers and lenders in the most efficient way possible. There are some factors that determine how fast your investment is utilized. For one, reinvested cash is always given priority. New money is considered a lot more high-risk and might not instantly get matched with borrowers. However, nothing can beat a good deal and that means you're never going to be too far from a successful investment option.
There’s a potential for tax-free benefits
If you plan on investing significant amounts of money into a peer to peer lending system, you're probably expecting a lot of profit to go into taxes. However, this isn't necessarily always the case. If you earn more money on interest than the remainder of your personal savings allowance, peer to peer lending can end up being tax-free. If you're in a position to open an Innovative Finance ISA, you can utilize them to reduce your taxes and maximize your potential earnings.
IFISAs are run by the peer to peer businesses and they are made to be beneficial to the lenders and investors that use their services. Keep in mind that the amount of savings you can make through IFISAs is limited. How much you invest and save is limited on a yearly basis, which is why you need to crunch the numbers before investing. At the same time, opening an IFISA might not even be necessary if your interest is below your tax allowance. This is automatically deducted from your taxes anyway, but it’s good to check if an IFISA might be able to further decrease your taxes.
Cash isn’t lent immediately
Investors that are looking to make a quick buck with the right peer to peer lending platform will be disappointed to find out that it takes a while for them to process a transaction. There are checks that need to be made before the money is lent and this is often considered a big minus for both the lender and the person seeking funding. You’re not gaining any interest while you wait, which is a big minus for your investment.
On the other hand, the wait isn’t all that long and it shouldn’t affect your interest earnings in the long run. These platforms are eager to approve your loan and get their own percentage, so they’ll be working to get everything ready as soon as possible. Even if the money takes a while to be sent, you’re still getting your intended returns very quickly, despite being slowed down slightly.
Funds often need to be locked
If you’re an experienced investor, you’re going to want the best rates and terms possible on the loans that you invest. When it comes to peer to peer lending, this can mean locking your funds for a while before actually utilizing them. Many of these platforms require that you keep your funds under lock for months to make proper use of them. Your savings might not be available for quite a while to help increase returns.
On the other hand, this is basically true for a lot of good long-term investments. You will often have to temporarily sacrifice liquidity in order to get the best possible results. This kind of commitment is beneficial in the long run. It's just another normal part of investing that happens to be true for peer to peer lenders as well. This lack of flexibility can be off-putting for newcomer investors, but it’s still a considered worthwhile wait for many.
It’s a chance to invest ethically
There’s one often-overlooked benefit of systems such as peer to peer lending. They don’t require you to invest through shady channels to earn money through interest. It’s a well-known fact that many banks and building societies often cooperate with shady businesses and groups, making investing with them a grey moral area.
The ethical investments that peer to peer lending can provide you are a very attractive perk of these systems and platforms. Most people aren’t fully aware of the many different investment options available to them, and they often disregard options that are presented through online channels. After all, what is peer to peer lending compared to more well-established investment choices? As it turns out, it’s a potentially ethical alternative that more and more investors are starting to warm up to.
Peer to peer platforms offer fair and clear services to both their clients and investors. They operate with transparency, meaning that investors can have peace of mind when using these services to make money.
Risk diversification
Spreading your capital across several different platforms allows you to minimize the amount of risk you’re taking with your investment. Peer to peer lending allows you to communicate with multiple borrowing parties which will all have different expectations of your terms and investment.
You can better manage your exposure to risk in case you default. If you do the math, you’ll note that peer to peer financial backing allows you to avoid enormous losses if you utilize many borrowers. For example, investing ten thousand dollars is considered a high-risk move. If you default on just one of those loans, your losses can reach up to a thousand dollars. However, investing with many borrowers reduces this risk. If you instead utilize a hundred borrowing parties, defaulting on just one will cost you a mere hundred dollars. It’s a humongous reduction in risk and your potential for losses from small mistakes are drastically reduced.
Peer to peer lending allows you to better manage your risk exposure. Utilize countless borrower options and you’re going to find it a lot easier to avoid having major losses.
Conclusion
It’s not hard to explain the rising popularity of peer to peer lending. It’s an investment option that offers a different kind of freedom to investors all over the world. Instead of interacting through a middleman, investors are able to almost directly communicate with businesses and individuals that seek their funds and determine whether they’re a risky investment or not. It also allows investors to circumvent unnecessary restrictions and get to their investments in shorter amounts of time. Consider these pointers before deciding to invest and you might just see some very good results from investing in peer to peer lending.