With the low returns from banks and the high risks associated with the stock market, people often find themselves looking for new investment options.
One such investment which is taking the financial world by a storm is peer to peer lending. This borrowing and investing mechanism has seen fast growth in the past decade and is becoming quite popular among smart investors.
An introduction to P2P lending:
P2P lending is one of those investment options which is characterised by high returns and low risks. This is the process through which borrowers get loans directly from the lenders, usually facilitated by an online platform.
Thus, these platforms act as intermediaries and bring together borrowers and lenders to interact. As an investor, you can invest in loans to pre-screened borrowers and earn higher returns on your investments than traditional banks.
The risk associated with P2P lending:
The main risk related to P2P lending is the risk of the borrowers defaulting and failing to pay their debts. There are ways to reduce this risk, but more on that later.
In such a case of default, the peer to peer lending platforms deploy their own human resources to recover your money for no additional fees. Some platforms also offer third party legal opinion.
Peer to peer lending is one of the most attractive alternative investments currently in the scenario. Though it is associated with low risks, yet your money could be in jeopardy if you’re not smart about your investment.
And, as is the case with any other investment option, higher risks mean higher returns. But, these rules below will not only help you to mitigate and reduce the risks but also help you earn more.
Check the history of the platform and its credit rating process
Before starting with the investment, check the history and past performance of the peer to peer lending platform. Even though past performance is not a guarantee of future results, yet it’s better to start the investing process with a peaceful mind.
Also, check the credit rating process of the platform. P2P lending platforms enlist borrowers after assessing their creditworthiness through different methods. When you choose a platform to work with, you would not be meeting the borrowers personally.
Hence, understand the credit rating process of the platform. The more thorough it is, the lower would be your risk.
Go through the details of all the borrowers individually
This may be a time taking and exhausting process, but it’s definitely worth your time. Make sure to thoroughly go through the details of the borrowers before selecting among them to invest in.
Carefully assess the information provided by the platform to understand their capabilities and intentions to repay.
Create a diversified portfolio
Diversification is a rule which works in all investments. In peer to peer lending mechanism you should diversify your investment. This means you should divide your entire investment into smaller amounts and invest in not one but a number of borrowers.
This helps you minimize the risk of default. Even if one borrower defaults, your entire investment does not go down with him/her.
A platform which assists in loan recovery would be better
Even though there are a lot of ways to reduce risks, you cannot eliminate them completely. You have to bear certain risks no matter what. In the case of peer to peer lending, such a risk is the risk of default.
Even if you take all the necessary precautions and choose borrowers with great credit score, they might still default on their loans. Hence, it is wise to invest on those platforms which provide support in helping you collect the defaulting loans.
Ensure the transparency of the whole lending process
After checking the history of the platform and the creditworthiness of the borrowers, you should ensure that the whole process is transparent when it comes down to lending your money.
The peer to peer lending platform you have chosen should have a non-ambiguous and transparent policy so that you can see where your hard-earned money is going. After all, everybody likes to sleep with a peaceful mind.
Begin investing slowly and know your appetite for risk
Do not be in a rush to spend all your money and earn returns. If you do so, you will find yourself in an overwhelming situation. It is wise to begin investing slowly which would buy you time to understand the entire process. Also, invest according to the risk you are comfortable with.
Do not step outside of your comfort zone and invest in high risk borrowers to earn high returns. You need to be smart about your investment and sleepless nights are no good for it.
Peer to peer lending is one of the most revolutionary and disruptive financial innovations of our times. This alternative investment option is increasingly being preferred by investors and borrowers alike. It provides those who have been left behind a chance towards financial inclusion. And the future of peer to peer lending also seems bright in India!