What to Invest in, Part III—Peer-to-Peer
Episode #5 of the course Investing money for beginners by Maureen McGuinness
As we explored yesterday, you can earn a steady return on a debt investment. Another way of buying debt investments is through peer-to-peer lending.
Peer-to-peer lending (P2P) is a relatively new way of investing (just over a decade old). Here’s how it works:
1. An investor pays $100 into the platform.
2. The platform divides the $100 dollars into smaller piles of money, e.g. five piles of $20 each.
3. The platform lends $20 to five different borrowers with varying credit ratings.
4. The borrower pays the loan and interest back over time.
5. The platform takes a small fee from the interest, then returns the capital, plus leftover interest to the investor.
If the above process sounds familiar, it’s because this is exactly the same process that big banks use when you open a savings account or take out a loan. The difference is that big banks take a bigger cut of your interest and often charge a higher rate to the borrower. Like traditional bonds, peer-to-peer lending gains are made when you hold your investments for the full terms as determined at the outset, so keep in mind how long you wish to invest before signing up for any of the following platforms. Generally, P2P loan terms are between three to five years.
In the US, there are the following peer-to-peer lenders:
1. Lending Club
Lending Club is the world’s largest P2P lending platform, offering both personal loans and small business loans. It started in 2005, so it is one of the oldest peer-to-peer lenders in the US. It also enables not only individuals to invest but also institutions.
Minimum Investment: $1,000
Interest rates: 4-6%
Fee: 1%
Eligibility: You must meet specific requirements.
2. Prosper
Prosper was the first P2P platform in the US and requires only a small amount of money to start investing. When you invest through this platform, you lend to individuals.
Minimum Investment: $25
Interest rates: 7.41% on average
Fee: 1% annual loan servicing fee
Eligibility: You must meet specific requirements.
In the UK, there are three main peer-to-peer lenders:
1. Zopa
One of the earliest platforms to offer peer-to-peer lending, Zopa has been operating since 2005. Zopa’s popularity means that new investors now have to join a waiting list. When you invest money into Zopa, you lend money to individuals who are seeking loans for a new car, home improvements, holiday, wedding, or to consolidate their existing debts.
Minimum Investment: £1,000
Interest rates: 6.1% after fees and bad debt
Fee: 1% if you need to sell your loans early
Eligibility: You need to become a UK resident and join the waiting list.
2. Ratesetter
Slightly younger than Zopa, Ratesetter started in 2009 and offers a similar service by lending money to individual borrowers. It boasts higher rates of return than Zopa and is accepting new investors.
Minimum Investment: £10
Interest rates: 3.2% (easy access), 2% (one year), 4% (five years) after fees and bad debt
Fee: Average of 2.51% if you sell your loans early
Eligibility: You must be a UK or Australian resident.
3. Funding Circle (also in US)
Like Zopa, Funding Circle is viewed as an older platform and has been operating since 2010. The key difference between Zopa and Funding Circle is the borrower profile. With Funding Circle, when you lend money as an investor, you are lending money to a business instead of an individual. Lending to a business comes with more risk than lending to an individual, which means that Funding Circle offers investors a higher rate of return, with the caveat that they may lose more money than through a platform like Zopa.
Minimum Investment: £20
Interest rates: 4.8% if you’re cautious or 7.5% if you’re willing to take more risk
Fee: 1% annual fee
Eligibility: You need to be a resident of one of these countries: Germany, the Netherlands, UK, and US.
P2P platforms provide you with the flexibility to take your earnings as income (which sometimes can arrive daily, depending on how much you’ve invested) or to reinvest any interest by lending it out as new loans. Reinvesting income from P2P loans can help you achieve a compounding effect (where you grow money from the interest earned from your previous investment and from the initial one).
That’s a wrap on lending money to earn a return on your investments! Tomorrow, we’ll be looking at one of the more traditional ways to invest money: property.
Recommended book
You Are a Badass at Making Money: Master the Mindset of Wealth by Jen Sincero
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