Want to run your own credit card company or loan department without really doing so? Too often as traders and investors, we neglect to consider alternative sources of return on capital. Enter peer to peer lending.
As many of us know, there are other markets that can produce similar yields and sometimes with less risk. And as I speak with other market participants about alternative investments, the constant question of yield inevitably comes up. Afterall, with rates on CDs (Certificates of Deposit) pretty low, it is just normal for any individual who would like to grow his/her portfolio within their personal risk tolerance to ask about alternatives.
So, just what is peer to peer lending? It is basically a type of crowdfunding service where borrowers can come to present their loan request to investors willing to lend. Since the personal loans are unsecured, borrowers will need to provide information including employment and date of birth. In addition, intending borrowers will need to agree to a credit profile authorization. Websites such as Prosper.com and Lendingclub.com act as the intermediary and thus do all the verification of the information provided. Lenders also need to provide some information for tax purposes. As a lender, one is able to view approved borrowers’ loan requests and can opt to allocate a portion of their cash to lend and help fund the loan request. Interest rates are determined by the borrower’s credit profile. A loan with a higher interest rate means the credit profile of the borrower is at the lower end of the credit range and likely carries more risk. Thus, if one decides to become an investor and lend money, one should be diligent in analyzing borrowers’ credentials as well as understanding the pool of borrowers one intends to lend to. Those in the lower end of the credit ranking obviously carries more risk. The investor is compensated for this increased risk by being able to charge a higher interest rate. Along with other investors investing, the loan request can be fully funded and the loan goes into effect. Repayment by the borrower eventually is spread across all the lenders/investors monthly and it includes interest as well as payment on capital.
Note that this is simply a recap of the capabilities of this type of alternative investment category with a few websites that operate in the peer to peer lending space. There are many more details and decisions that individuals will need to make that are not covered in this article. Clearly, interested parties need to due their own due diligence. That said, I want to briefly discuss why peer-to-peer lending appeals to me and why I allocate a portion of my total portfolio to this method. Again, this is my personal experience.
I started off with Prosper.com but eventually moved everything to Lendingclub.com for reasons I cannot seem to recall. Drawing from my experience, here are some highlights of why this strategy appeals to me:
- Allocation: Like I said earlier, there is chase for yield and I would like a higher rate of return than CDs and the like. Although more risk, being a peer lender allows me to achieve higher yields.
- Run my own credit card company or bank without all the hassle: Being an investor is like running a credit card company or a lending department at a local community bank. I can allocate anywhere from $25 to my full account size to any loan. I prefer to lend out in smaller amounts so as to reduce the risk involved with a borrower defaulting on a loan.
- Helping out: We’ve all witnessed a tightening of bank lending requirements, so this is one way to assist aspiring business owners. Through these sites, I feel like I can take on an appropriate amount of risk and still help out those who are serious about their personal financial situations. For instance, someone who would like to consolidate credit card debt with a 15% interest rate can opt to borrow at a lower interest rates (perhaps in the 7-10% range). Peer to peer lending assists borrowers while achieving investors’ needs too.
Personally, I have used peer to peer lending to actually net a return on my student loan incurred during grad school. My student loan has a fixed rate of 3.21%, whereas my loan portfolio in Lendingclub.com yields 8.77% and I have yet to experience a default on 64 issued loan notes. Instead of fully paying my student loan off, I decided to invest that same money as a peer lender in Lendingclub.com.
The interest that accumulates each month is more than enough to cover the monthly payment for my student loan seeing that there is about a 5.5% interest rate differential. I can also reinvest any interest+capital payments I receive.
Once again, to be clear, this is simply my personal experience and not an endorsement. As always, investors need to due their own due diligence and figure out if an investment type fits with their risk profile. That said, investors seeking returns from alternative investments in 2014 and years to come, may want to give peer to peer lending a look. Thanks for reading.
Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.