How to Make Money With Peer to Peer Lending - The Pros and Cons
Here's how you - can become a bank. Lending your hard earned cash to others and charging interest.
In this article we'll go over peer to peer lending as an alternative investment. Is it worth it? How risky is it? What's the return rate like and more.
So because the stock market is at an all time high - I have been looking at alternatives investments to diversify my portfolio. Peer to peer lending has been on my radar for a while and I finally decided to give it a try.
I finally took a leap - funded my Prosper account with $5,000 and selected a few loans to fund.
This isn't a platform review so I won't get into that but it could definitely be improved.
What is Peer to Peer Lending
These are websites such as Prosper or Lending Club calm that just act as an intermediary to match peers who need to borrow money with peers who have money to lend.
Because these companies have a lower overhead compared to banks they're able to lend money at a lower interest rate to borrowers and allow us to lend money that was previously reserved for larger banks or commercial lenders.
So they're offering us the opportunity to be the bank for someone else and get paid back that interest and the other benefits of doing this are that we don't need to lend all of our money to a single person either, instead, we could spread out our money towards hundreds of different people with as little as $25 per loan.
They charge an interest rate that's according to the creditworthiness of that borrower. So for a borrower with great credit, great income, and low debt according to their site so-called risk analysis which I disagree with and it's a huge concern of mine that I will address a little bit later on in this article could hypothetically have an interest rate as low as 6.46% annually.
Whereas maybe someone else who has nothing to lose with terrible credit, terrible debt, and terrible income who has a high risk of default would be as high as 27%.
POSITIVES 🍀
Invest with as little as $25
Most of the platforms allow investors to put in as little as $25 into a single loan.
Self-determined returns and risk
You can also select who you lend the money to. The platforms provide you will all sorts of details on the borrower. Like income, credit, the reason for the loan and you make the decision. There is a rating system that will let you know an A-F rating. A is safer with less return and F of course is much riskier with much higher returns. It's up to you to build a well-balanced portfolio.
Potential for passive income
A great advantage of investing in peer-to-peer loans is that passive income can be generated. This is because the loans are repaid on a monthly basis and thus the investment amounts and the interest earned flow back to you as an investor on a regular basis. In this way, you can build up a nice additional income that flows fully automatically. With passive income, investors can therefore generate another source of income for themselves, which is also independent of developments on the money and capital markets.
NEGATIVES 🚨
Fees
Now first we have the inevitable fees and this has got to be my least favorite word in the entire English dictionary.
They charge you a 1% fee from any amounts of money collected from the borrower so from whatever return you are anticipating you were gonna just subtract 1% from that.
1% fee seems high especially since they're also collecting up to six percent from the borrower. Most index funds are below 0.5%.
So now if you're anything like me you're starting to wonder what are the chances of actually getting my money back if a borrower just decides not to pay. Of course, I did some research into this and I found out that according to the New York Fed only about 12 to 13 percent of consumers paid back debt collected by a third-party collection.
Let's call that like your chances of getting your money back are 1 in 10. So that then got me thinking even more. What are the chances that one of these borrowers is just going to default on the loan and how often does this happen and what I found was pretty shocking?
According to them, since their entire history beginning back in 2007 they've issued nearly $32 billion dollars worth of loans and from that $2.5 billion dollars has been charged off and unpaid.
This means that there's a default rate of about 7.8 percent overall over their entire history of operations. so this means for every 100 loans you issue chances are of those about 8% are not going to pay you back and are going to let that just slide and walk away.
Lack of Liquidity
It becomes very difficult to pull your money out. Once you invest in one of these notes technically you're tying up your money for three to five years until that loan is paid off and matures and that also assumes that your loan is paid off on time. If not hypothetically this loan could be going on even a little bit longer than that.
So if you need your money any sooner than this you're forced to sell all of your notes on the secondary market usually for a very steep discount. which means that you might only receive back between sixty and eighty percent of whatever your remaining balance.
Income Taxation
This part hurt and I only found out later on - but hey - we're here to learn and now you don't have to make the same mistakes I did. Let's say you do invest with them and you do get a decent return well then the next issue that I see here and it's a very big one is taxes and that this is taxed as ordinary income as for the IRS and that means it's taxed at your highest marginal tax rate. depending on how much money you currently make this could end up being a lot of money. when you compare something like that to long-term capital gains which for most people you're watching is just 15%.
If the money is tied up for 3-5 years in most other investments you would be paying long-term cap gains but in this case, it's a lose-lose.
Stated Income
Prosper assumes no risk and analyzes the creditworthiness of the borrower, as noted by what they say here in their fine print.
Member loans are made without obtaining any documentation of the borrower applicant's ability to afford the loan. then you have this gem sentence right here although we may perform income verification the platform's underwriting credit and pricing decisions may be based on stated borrower income rather than the verified income.
When's the last time we saw people using stated income? Oh, right that was like 2006 and 2007
Lying on an application is fraud but what are the chances that any of these peer-to-peer lending websites are going to go after someone and prove that they lied on the application when it's simply easier just to write it off it's a loss sell it off to the third-party collections agency and then move on to whatever is next.
Let me know what you think and if you would consider trying it out. You can also DM me on insta for a progress update on how my $5,000 is doing.