Peer-to-Peer Lending Risks – Is P2P Lending Safe?

Do you want to know exactly what the peer-to-peer lending risks are? Is it safe to invest in P2P lending, and what are the steps you can take?

When you’re investing your money, there is always a particular risk involved. As with any other investment you want to do, you need to conduct due diligence and research if the risks involved are something you can take. And P2P lending is certainly no exception to the rule. 

Lending money is already a tricky undertaking, whether it be social lending or consumer lending from big banks. But there are more and more lending companies around aside from the traditional bank setup, and you know why? Because of the probability of high yields and high rate of return despite the inherent at-risk of the loan market.

When you’re considering investing in peer-to-peer (P2P) lending, you should be aware of the lending risks. Crowdlending is something that can lead to much higher returns compared to other investment vehicles. Peer-to-peer loans are an alternative lending method used for consumer loans, startups, and small businesses, thus attracting the lending industry. 

The possibility to prosper as an individual investor in this kind of alternative finance is due to the interest payment for these types of loans. Still, you need to know and understand that there is a risky part in the lending side. When you have higher returns, you have a higher risk. 

Although it might not feel like you know what the scary stock market is doing, it might be more consistent over time. 

Go here to learn more about P2P lending:

• 9 Best Real Estate Crowdlending Platforms
• Top P2P Sign-Up Bonuses & Cashback Links
• How To Start With Peer-To-Peer Lending

It would make sense to dive deeper into peer-to-peer lending risks since various risks can be associated with investing in P2P platforms. These risks are important to consider when you want to make P2P lending a part of your portfolio.

When we are analyzing peer-to-peer lending safety, there is a variety of risks with different impacts on your investments:

1. Money drag – the money you have is not fully invested in projects.
2. Borrower default – the borrower defaults on the loan you have invested in.
3. Loan originator bankruptcy – the loan originator is not able to fulfill its obligations and goes bankrupt.
4. Platform bankruptcy risk – the P2P lending platform goes bankrupt or stops its business and defaults on all the loans you’ve invested in.
5. Economics risks – macroeconomic movements like an economic downturn or political uncertainty can move the entire market in a different direction.

Peer-To-Peer Lending Platforms

Before we head on with P2P lending risks. Here are some trusted platforms aside from the banking system that you can try for your P2P lending investments.

• Mintos – largest P2P investment platform and lending space in Europe, over 50 lenders available, and a wide range of investments. Sign-up now and get 0.5% of your invested amount in the first 90 days. Check out our full Mintos review for more information.
• Reinvest24 – a property crowdfunding site where you can receive income from growing property valuations and renting out the properties. Read our full Reinvest24 review here.
• EstateGuru – is an European real estate crowdfunding platform for property-backed loans provided to businesses. Here is our full EstateGuru review to check.
• Nibble Finance – is an European peer-to-peer platform that lets you invest 100% automated. Here is out full Nibble Finance review for all the ins and outs.

Peer-To-Peer Lending Risks

The peer-to-peer lending risks are very serious, and you should certainly attend to them. Let’s dive straight into peer-to-peer lending risks – and how you can diminish the risk you’re taking!

P2P Lending Risk #1 – Money Drag

Money drag means that your money is not fully invested. This is the risk that some of your money is not earning you any income. This is the least serious risk that you have when investing in crowdfunding platforms.

When you’re investing in P2P loans, they have different repayment terms. Once the loan has been paid off or you receive interest, you get money in your account. You will have to re-invest that money in your investment account. 

One easy way to do this is by using the auto-invest feature that is available on many platforms.

When you’re investing using the auto-invest feature and your money is still not invested, there may be no loans available that have your desired loan criteria. 

Having a money drag is no big financial disaster. You’re simply not investing all your money. Meaning that the money you don’t have invested on the platform is getting you a 0% return on investment. 

This is the least serious risk of P2P lending. It’s simply not desirable. 

How To Mitigate Risk #1?

Money drag is only a problem on a few platforms. While it has not been a problem that I have experienced, it is something that investors can experience from time to time.

When using platforms like Mintos, which has an auto-invest functionality, the problem is easy to solve. 

In any case, you should check your investments at least once a month. Depending on your preference, you can check your investments more often, for example, weekly.

This lets you know if you have a money drag that prevents you from getting an optimal return on investment. 

If you notice a money drag, you can adjust your loan criteria (lower interest rates, longer loan terms, other loan originators, and more) to invest more of your money. 

When that doesn’t solve your money drag problem, it might be best to take your money and invest it in another P2P lending platform. I haven’t experienced any cash drag with the platforms I’m currently investing in, like Mintos or Reinvest24.

P2P Lending Risk #2 – Borrower Default

In short: borrower default means that the borrower is not able to repay the loan.

When you’re investing in peer-to-peer lending, you are loaning money. Depending on your platform, you loan money to an individual or a business.

You can probably imagine that when you loan people or businesses money, there is a risk that the other person will not pay you back. We call this defaulting on a loan amount.

If this happens, you will probably already have gotten back some of your investment. Of course, you want all of it!!

The platform you are investing your money in is trying to get your money back through various legal procedures. However, the risk is that you’re losing your money. 

How To Mitigate Risk #2?

With many P2P lending platforms, they make it simple to mitigate the borrower default risk.

Why? Because many P2P platforms provide a buyback guarantee, where they buy back the loan from you when the borrower is late with payments (often between 30-60 days late). Most of the platforms also recover for your lost interest rate when this kind of event occurs. 

I only invest in crowdlending platforms that offer a buyback guarantee on loans. There are some platforms that provide loans with and without a buyback guarantee, so be sure to choose loans with a buyback guarantee. 

When you choose to invest in loans without a buyback guarantee, make sure that you’re doing your own research – and dive into every detail you can find. This way, you can determine what the risk associated with the return you will receive is. A general rule of thumb is: the higher the interest rate, the higher the risk (chance of default in this case). 

Another way to prevent borrower default is by selecting many different small loans. Doing that prevents one borrower from having a big effect on your returns. I don’t invest more than €100 per loan. 

P2P Lending Risk #3 – Loan Originator Default

There are two different kinds of P2P lending platforms:

1. P2P lending platforms that offer loans from different origination of loans.
2. P2P lending platforms that offer loans themselves (no third party involved) – are often fewer and larger loans.

For the platform that does not use any third-party loan originators, loan originator bankruptcy is the same as platform bankruptcy (the next P2P lending risk).

However, if you invest in platforms with many loan originators, loan originator default risk is important. When one of the loan originators you’re investing in defaults, you may lose many of your investments with that specific loan originator.

When a loan originator defaults, the P2P lending platform sends their lawyers and tries to recover the investment through standard bankruptcy procedures. 

It is rare to have a loan originator default, but it has happened once with Mintos. When they default, the damage is big – so you want to prevent this when possible.

How To Mitigate Risk #3?

The two most important things to mitigate the risk of loan originator default bankruptcies are: diversify among loan originators, and do your own research. 

Diversified investment among multiple loan originators is important to minimize your risk of loan originator default. When you diversify your loans, it won’t have such a big impact on your total investment since you’re investing with many different loan originators. Diversification is really a key investment strategy.

Doing your own research is always important, especially when you want to prevent loan originator default. You can check which loan originator you feel comfortable investing your money with.

A platform like Mintos has its own risk rating of its loan originators. While I think it’s great that they do that, not all their research is equally detailed. That’s why I have researched for myself which Mintos loan originators I feel comfortable investing in.

It is very important that you only invest in loan originators with good numbers, where you feel comfortable putting your money.

P2P Lending Risk #4 – Platform Bankruptcy

While all three lending risks outlined before are important, we are now getting into the very serious risks of P2P investing. 

A platform bankruptcy is a serious threat to your entire investment – when a platform goes bankrupt, you can lose all the money you invested. A lending company always carries the risk of closure due to bad debt.

How To Mitigate Risk #4?

I will repeat myself a bit here, but the advice stays important: do your own research and stick to platforms you feel comfortable with. 

Before you invest your money in any platform, you should research them carefully. Different P2P platforms are registered in other countries with different legislation.

When you’re investing in Europe, some platforms might have this loan deposit guarantee, meaning that up to an X amount, the government will refund your money when a platform defaults. 

Don’t invest in a platform simply because someone you know invests with that platform.

In February 2019, a platform called Envestio got into big trouble – they couldn’t pay back their investors anymore. They took their website offline, and since that day, no one has heard from them. This is not the only platform that is taken offline over time. Other platforms have fallen too.

While the advice was to diversify, I would urge you to only invest in platforms you fully know and trust.

I invest in four different P2P lending platforms now, and I trust these platforms fully. I only invest in platforms that I fully trust and that are already established in the market. At this moment, I am not concerned about any platform I invest in. 

P2P Lending Risk #5 – Economic Risks

Now we’re not only talking about the P2P lending market but the entire world economy. Certain factors can influence the whole economy that will certainly hit the peer-to-peer market.

These economic risks are market downturns, recession, political tensions, or perhaps even a global pandemic. Financial services take these into account, and so should you.

These economic and global risks may influence the ability of platforms and borrowers to pay the money back. We haven’t seen yet how peer-to-peer lending platforms will act when there is another financial market downturn. If there will be people losing their income and loan originators not getting paid, I can imagine that some platforms or loan originators may not make it. 

Besides that, interest rates have been historically low for the entire period that P2P lending arose. If the interest rate rises, people might lose interest in the P2P lending sector and perhaps no longer find it worth the risk. 

These are market risks that arise from macro-economic movements like financial downturns.

How To Mitigate Risk #5?

The macro-economic movements and political developments are very unpredictable. In many cases, it will hit unexpectedly and there is very little you can do.

There is only one type of investment advice that I would give in that case: never invest money you can’t afford to lose.

It’s far from the ideal situation, but that is the unfortunate truth.

The best way to mitigate this risk is to invest only a small portion of your portfolio in peer-to-peer investing. Between 10-15% of your total portfolio may vary depending on your risk appetite and personal preference. 

Now that you know the risks and how to mitigate them. Let’s see some side hustles that you can do aside from peer-to-peer lending to help boost your finances. You may also consider finding companies with the best benefits to help you with your job.

If you have a lot of free time, try watching movies on Netflix and earn. You may also join clinical trials that can make you some extra dollars. If you love chatting with people, there are phone actress jobs that you can also try if it would align with your goals.

Check out Fiverr and Flexjobs to look for more side hustles that will best suit you. Read more about Flexjobs review and learn the benefits of using the platform in finding the right gig for you.

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Peer-To-Peer Lending Risks – Should I Invest In P2P Lending?

That’s up to you. I do not recommend investing in P2P lending if you cannot afford to lose your investment. If you have money for high-risk, high-return investments (10-20% return), you could consider investing in P2P lending. 

Personally, I would recommend investing about 10% of your assets in P2P lending. It is a high-risk, high-return kind of investment. My current average returns are about 13%, and it’s money that I can miss, meaning it’s a risk I’m willing to take. Lending and investment is a good venture that doesn’t need a big working capital to build your own money-making machine.

Start investing but make sure the amount you lend is within your comfort zone. Lending opportunities will always be there because there will always be personal loans, business loans, or a need for loan purposes. Online lending is a high-risk and high-reward business model. You can lend money and earn based on the principal and interest on the money that was borrowed. 

This is a sound lending model with a proven track record, but you are bound by the fulfillment of the responsibilities of these online lenders. 

What do you think about peer-to-peer lending safety?