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Understanding The Risks Involved In Peer To Peer Lending

by Intizar Ali
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Peer to peer lending, also known as p2p lending, is a popular way of investment among yield-seeking investors. It matches potential borrowers with the investors who want to lend money. P2p lending cuts the middleman and makes borrowing and lending easy. Borrowers can easily get funds directly from the lenders, while lenders can earn a high rate of return. This type of lending is carried out through online platforms. That is why investors find it a convenient way to invest without going to banks or any agent. No doubt, p2p lending offers fantastic returns. Like all other investments, it also has some risks. It is essential to understand the risks involved so that you can take measures to mitigate these risks.

Keep on reading to know about risks associated with peer to peer lending.

Risk Of Default

Although all peer to peer platforms lend money to creditworthy borrowers who have a good credit history and can afford to repay the loan amount, still there exists a risk that some borrowers may default on their loans. It can happen due to unforeseen circumstances such as illness or loss of a job, or it can be a result of a deliberate attempt to defraud. When a borrower defaults, it can affect the returns that you receive. However, reputable lending platforms take measures to protect investors from any negative impact. There are some reserve funds that platforms use to pay out in the event of missed or late payments. These funds are maintained by using part of arrangement fees and interest rates that borrowers pay.

Other than that, some platforms take a number of insurance policies to protect their lenders from defaults, fraud and cybercrime. However, keep in mind that the contingency fund does not provide protection when more than one borrower defaults simultaneously.

P2P Platform Goes Bust

When investing in p2p lending, investors are concerned about what would happen if the lending site goes out of business. No most of the peer to peer platforms are regulated by the Financial Conduct Authority (FCA). FCA made it mandatory for all the p2p lending sites to maintain contingency arrangements in order to manage all their loans when they no longer exist. 

Leading p2p lending sites make such arrangements with the help of back -up services. Although there is direct contact between borrowers and lenders, backup service providers manage the company’s loan book to make sure that borrowers are paying loan instalments at the time and lenders are receiving the expected interest payments. Backup service providers charge fees that can impact the returns. However, it provides confidence to lenders that their loan contracts are safe.

Moreover, most platforms keep lending funds in a ring-fenced Trust and completely separate from day to day operations of the platform. The platforms have no access to these funds, and if a company goes bust, all the un-lent funds could be returned to the lenders.

Funds Not Lent Quickly

When you invest money through a peer to peer lending platform, it becomes available to lend. But you can earn interest only when you find a borrower seeking a loan over the same terms. So there is a risk that it may take a long time in finding a borrower that matches your lending terms. Therefore, you may receive fewer returns than your expectations. However, if you want to earn high returns, you must invest for a longer time.

Some lending platforms help you to invest in a better way by minimising the time taken to match offers.

No Protection by Government 

When you invest in peer to peer lending, your investment is not protected through the Financial Services Compensation Scheme. It means if you lose money, the government is not responsible for compensating for your loss. 

These are the risks that you should keep in mind before investing in p2p lending. However, you can see that peer to peer platforms take all possible measures to reduce these risks. That is why it is crucial to choose a well-reputed and experienced lending platform. There are several peer to peer platforms in the UK, and you can shop around, check online reviews and track records of platforms to select the best one.

In addition, when you know all the risks that are associated with peer to peer investment, you can take measures to reduce the risk. For example, you can mitigate the risk of default by diversification. When you spread your investment across multiple loans, you will not lose all your investment even if a borrower defaults. One other thing that you should keep in mind is not to invest all your capital. Start from a small amount, understand peer to peer lending completely and then increase your investment gradually. Furthermore, select a platform that is regulated and authorised by the Financial Conduct Authority (FCA) and follow best lending practices.

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