Friday, May 2, 2014

P2P Lending

P2P means Peer-to-Peer. The concept is that the P2P lending website connects individual investors (lenders) with those who need a loan (borrowers) as an alternative to going to a bank.

I have an account with Lending Club, so I actually own thousands of loans (notes). As people make payments to Lending Club, Lending Club credits you with both the principal repayment and the interest. My comments will be in relation to Lending Club, but I imagine other P2P options would be similar. I basically went through the different aspects I think about before placing my money somewhere.

1 – Risk of losing your principal investment: P2P lending websites assess their borrowers’ credit scores and provides ratings on the notes. The key to P2P lending is diversification. The smallest note available is $25 in original principal. If you are buying notes that others are selling, some of that principal has already been paid out so the note cost is even less. I started with $2,500 and bought approximately 100 notes. By doing this, if a couple defaulted, the interest I earned on the other loans would easily outweigh those defaults. I pick highly rates notes from parties whose credit score has either stayed the same or increased to further reduce my risk. There’s a lot of information on the lending club website about this risk issue.
2 – Liquidity as to income stream: Money is constantly coming into my account because all the different notes have different due dates. The more loans you own, the more this would be true for you. You can withdraw from your cash portion of your account at any time and it will be in your bank account within a couple days.
3 – Liquidity as to principal investment: With every payment that comes in, you receive some of your principal investment back. Additionally, you can trade your notes. However, I would stay away from that because you will probably have to sell at par value or maybe a slight discount and Lending Club will take a cut.
4 – Fees: While Lending Club does get a cut with each loan, the fees end up being quite minimal.
5 – Return: A feature I love about this is that it calculates your APR. If I assume that any notes that are currently in the grace period or past due will default, my APR is ____ . From what I’ve read, if your portfolio uses higher risk loans, your return still comes out around this level (bigger return on the ones that do get paid back, but all the defaulting loans drive down your return.)
6 – Risk of a lower than expected return: The borrowers’ interest rate does not fluctuate so the concern here would be an excessive number of defaults. By buying many small loans, my return has been quite steady.
7 – Institutional investment minimum and maximums: There is no minimum or maximum investment.
8 – Effective Investment minimum and maximums: To minimize risk, you may want to establish a diversification minimum for yourself (for me that was the $2,500 so I could get at least 100 notes). Due to note availability within my desired criteria, I’m starting to think I need to reduce my account size and find somewhere else to invest.
9 – Effort: There is a filter when you shop for notes and that makes it really simple to identify which loans fit your criteria. However, you constantly have to buy new loans to maintain the same level of investment because your original investment is constantly coming back in the form of principal payments. As discussed above, lately I’m finding that there are not enough notes for me to buy, so I have to check for new loans several times a week. Due to Oklahoma law, I can only trade notes that have already been issued and consequently I am redirected to a different website to actually purchase notes. If you live somewhere else you could have a different experience.

How to get going?! - Lending Club or Prosper are the main two avenues for this, so go to their websites.

This is just my assessment of these options to get you started, but you should definitely look into it further for yourself. Leave a comment if you've either done this or are interested in it. 

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