“Glenn, can I invest in loans, or loan money online with these new p2p lending websites?”
My friend Ray asked me one day.
“Or, do you need need to be an accredited investor?” he continued.
Ray, like many others, are lower net worth individual investors, but want to explore how to invest in loans and p2p lending platforms.
Well, there’s good news.
Due to recent regulatory changes, you can now diversify your investments and loan money online.
Simply put, you can become the bank!
Now, because this post is super long and super badass, for the first time ever we are including a table of contents.
Table of Contents
- Invest in Loans: An Intro to P2P Lending
- P2P Lending – How It Works
- Invest in Loans: Old Bank Advantage
- Invest in Loans: Your Advantage and Returns
- Best P2P Lending Platforms
- Prosper Marketplace
- Funding Circle
- Can I Loan Money: Yes!
Let’s get started, and answer Ray’s question: Can I invest in loans?
Invest in Loans: An Intro to P2P Lending
Online lending, or peer-to-peer (P2P) lending as it’s commonly referred, is the process through which borrowers get loans directly from lenders, usually facilitated by an online platform.
These online platforms act as intermediaries matching borrowers and lenders.
Simple as that.
This presents an interesting opportunity for those looking to lend out money or diversify their income streams.
With P2P lending, you can invest in loans to pre-screened borrowers through powerful platforms. But more on this later.
To make money lending as an individual, you are no longer limited to loaning your buddy Ray $500 to get his food truck business off the ground.
Now, you can access pre-screened businesses and individuals who require a business or personal loan.
Let’s dig a little deeper into how to invest in loans.
P2P Lending – How It Works
While the idea might sound novel, the practice of borrowing and lending has existed for centuries. From inter-borrowing among friends and family to fundraising for causes.
Additionally, “traditional” banks are founded solely on the concept of aggregating depositors money and lending it forward to borrowers.
P2P lending has adapted the idea of lending money to our digital technology reality. And, as you will see, the results are powerful.
This has also opened up opportunities for ordinary people, like you, to take part in the “banking sector” as lenders.
So, yes Ray, you can loan money and invest in loans!
P2P lending through online platforms has some serious advantages.
P2P Lending: For Borrowers
- Lower interest rates on average. Online platforms don’t have branches or other major overheads enabling them to pass the cost benefits directly to borrowers.
- Faster processing of loans. Online lending platforms employ automated risk profile scoring algorithms that enable them to quickly determine the risk profile of a borrower.
- Loan terms are clearly stipulated. The days of combing through fine-print to find the hidden fees and charges are long gone.
P2P Lending: For Lenders or Investors
- Better risk adjusted returns. Most online platforms lend to people and businesses that may be considered riskier by traditional banks in terms of creditworthiness. This enables them to charge higher interest rates.
- Transparency in loan investments. Online platforms provide a variety of data for each loan giving the investor a clear understanding of what they are investing in.
- Access to a high-yield investment class. Let’s face it, the interest rates on your savings are earning a paltry amount. Online lending opens up a better option for lenders to earn better returns.
- Access to credit profiles for each approved loan. This enables an investor to make better and informed decisions on their investment.
However, as with any type of investment, if you invest in loans there’s still risks.
- Borrower credit risk. A borrower may default on the loan risking the lender’s investment.
- Liquidity and regulatory risks. P2P lending is a new concept and they are still legal gray areas being addressed.
- Investors bear more risk than borrowers. While a slightly different way of lending, normal borrower protections still apply. Among them are laws on usury, debt collection practices, regulations against discrimination for borrowers etc.
Apart from that, there are risks inherent in the platforms themselves. Some of these include:
- A limited operating history for most p2p lending platforms.
- Potential for fraud due to online anonymity.
- Inefficiencies in the proprietary credit risk scoring methods used on the lending platforms.
- Lack of clear regulations with regards to online p2p platforms.
- Stiff competition from traditional banks that are fast catching up.
Invest in Loans: Old Bank Advantage
The last point worth exploring is about traditional lenders; banks! Financial institutions have some distinct advantages when it comes to lending money.
- They enjoy a low cost of money since most are deposit takers. Their cost is about 0.6% compared to an average of about 10-15% for most online platforms.
- They have large borrower bases. Banks have been around for centuries and have gained the trust of most people. Online platforms, on the contrary, are still new and have to earn that trust.
- A huge asset base. Compared to online platforms, traditional banks are required by law to maintain huge asset bases. This not only means they have an upper hand when it comes to lending, but also the muscle to market their services and invest in R&D or marketing campaigns.
Traditional banks are fast catching up with some like Goldman Sachs, JP Morgan Chase and a host of others exploring options to participate in online lending.
However, it’s not all doom and gloom for p2p lending platforms.
They keep on innovating! But more on this in a moment.
Additionally, savvy investors continue to make extra cash from their online lending activities.
Invest in Loans: Your Advantage and Returns
How much? Well, depending on the loan risk, you can earn between 4-12% interest.
Consider if you invested $5,000 in a safe 6% personal loan, on which there was a 3-year term.
You would stand to earn:
There’s also this fancy calculator that will help you figure out your potential returns should you choose to loan money online.
OK, it’s time for the good stuff!
In the rest of this article we explore some of the best online lending platforms to invest in loans with.
We delve into how you too can be the bank and make extra money from the comfort of your home.
Best P2P Lending Platforms
Founded in 2006, Lending Club is one of the most popular and well known p2p lending platforms. It was also the first p2p lending company to go public in 2014.
Lending Club is a marketplace that brings lenders and borrowers together and facilitates their interaction.
Loans offered range from $1000 – $35,000 for personal loans while business loans start from $15,000 up to $300,000.
Simply put, this online platform allows you to loan money.
Lending Club offers loans for various purposes including personal (debt consolidation, home improvement, paying off credit cards etc), medical procedures to business loans.
The interest charged on loans can range from 5.99% for borrowers with good credit to 32.99% for borrowers with risky credit profiles.
Lending Club handles the bulk of loan processing and underwriting.
They also run credit checks on borrowers before approving any loans and generate a risk profile based on this and other factors. Once this is done, the borrower is assigned an interest rate.
The loan gets approved if when the borrower accepts the terms.
Once a loan is accepted, the loan goes live on the site giving investors a chance to take part in funding it. Lenders can put in a minimum of $25 on each loan allowing them to diversify their investments and minimize risk.
Historically, returns for investors have ranged between 4.9% for the safest loans to 8.3% for riskier loans. (include lending club graphic)
How to Invest in Loans with Lending Club
An investor/lender has to first open an account. This is an easy process that involves filling out a standard form. One can choose whether to open the account as a regular account or tax-deferred investment account (IRA).
Once your fill out your contact and tax information, you can go ahead to fund your account.
While there is no minimum, some states may require lenders to have a minimum income, usually around $70,000 or have at least $250,000 in net worth to be an eligible investor in the platform.
But again, this depends on your jurisdiction.
A minimum of $2500 is recommended for investors in order to have proper diversification in their loan investment portfolio.
After funding your account, you want to go ahead and pick the loans to invest in.
Let’s face it, money just sitting in your account doesn’t earn you any interest. You want to be as near 100% funds invested as possible.
Picking loans comes down to your preferences and risk profile. Understand that riskier loans may have higher returns but also have higher rates of default.
Investing in loans takes a bit of experimentation to find what works for each individual investor.
Have fun with it!
A few good rules of thumb however are worth pointing to help you get started when investing in loans:
- Look for borrowers with no pre-existing loan delinquencies
- Invest in borrowers with good work histories, preferably 10+ years
- Borrowers in tenured positions or with union protection are an added advantage.
- Filter for borrowers with a maximum debt-to-income ratio of 30%, meaning only a third of their income is tied up in servicing debt.
- Loans with at least 60-month repayment periods.
While this criteria alone won’t weed out all possible defaults, but it’s a great start when you loan money online through p2p lending platforms.
Additionally, it’s best to diversify your loan investments such that no individual loan takes the bulk of your investable loan money. This not only reduces risk but also improves your overall loan portfolio performance.
Lending Club has a feature that allows investors to automatically reinvest their income into loans without extra charges.
Simply set it up and any money that comes (principal + interest) is automatically re-invested.
If you don’t already know the power of this feature, also known as compound interest, read this.
Prosper was among the first peer-to-peer lending platforms launched in 2005. To date it has serviced more than $7B worth of marketplace loans.
Prosper loans are mostly used for personal purposes. One exception is that they can’t be used for post-secondary education since the Higher Education Opportunity Act prohibits it.
Loans disbursed range from a minimum of $2000 to a maximum amount of $35000. Prosper has instituted measures to reduce the risk to investors of borrowers defaulting. This include raising the minimum FICO score for borrowers from 520 the original to 640.
Additionally, Prosper uses its own proprietary algorithms to score borrowers and give each borrower a Prosper Score ranging from A – HR with A being stellar credit and HR being High Risk.
Can I Loan Money with Prosper?
Prosper is similar in many ways to Lending Club. There are eligibility criteria for lenders/investors.
- Being 18 years and over with a checking/savings account and
- Valid social security number
- Residing in an eligible state
- Some states also have additional eligibility requirements eg, having a minimum annual gross income of $70,000 and above and a net worth of the same amount to participate.
When a borrower makes a loan application, Prosper checks to see whether they meet the underwriting criteria. They run credit checks to ensure the 640 minimum FICO score is met and then assign the borrower a Prosper Score to denote their perceived risk on the loan.
Investors can invest a minimum of $15 on the loan once approved. Using the many filters available on the platform, an investor can filter out loans to invest in based on the risk profiles and a number of other factors.
This nifty feature makes investing in loans on Prosper very user-friendly.
What sets Prosper apart from other platforms is the ability to save your filters and invest in loans that meet your criteria automatically. You can set this up by using either Quick Invest or Automated Quick Invest (AQI).
When loans are added to the platform which happens twice a day, the filter runs and automatically invests your set amount in loans that fit your criteria.
Alternatively, investors who are technically savvy can utilize the Prosper API to run filters and automatically invest in loans. The API runs before the Automated Quick Invest giving API investors an edge. And let’s face it, speed is of utmost importance when investing in loans.
The reality is that when you invest in loans with higher returns, they also tend to attract more investors. The faster you are on the trigger, the higher your chances of making a decent return.
Funding Circle caters specifically to small businesses. Loans range from a minimum of $25,000 to $500,000.
To date the platform has disbursed over $3B in loans to over 20,000 businesses globally. Loans attract an interest rate of between 5.49% – 27.79% based on the borrower’s credit risk profile.
Funding Circle also charges an origination fee of between 0.99 and 6.99% on each loan.
Loans under $300,000 can be processed in under 10 minutes with the documentation required being at least 2 years of business tax returns and a year’s worth of personal returns.
Borrowers that need amounts above $300,000 may be required to submit additional documentation.
Loans on Funding Circle can used for any business purpose such as hiring, expansion, funding asset acquisition etc.
The platform boasts of over 60,000 retail investors including banks, national governments and financial institutions.
In early 2017 the company closed a $100M Equity financing round led by Accel further boosting it’s lending capacity. Funding Circle remains committed on building it’s brand as a small business lender.
So, how do you invest in loans with Funding Circle?
An investor can directly invest in a loan or they can purchase into the loan fund managed by Funding Circle.
The company purchases individual loans and bundles them into one investment, providing ample diversification and minimizing the risk of individual loan default.
Catering specifically to student loan debt and student loan debt refinancing, SoFi is unlike other p2p lending platforms and has strict lending criteria.
To qualify as a borrower one must:
- Be a US citizen or permanent resident
- Have no felonies on record
- Have no declared bankruptcies in the past 3 years
- Be currently employed or having an offer of employment
- Have a minimum credit score of 660 (the average on the platform is about 700.)
The platform welcomes both institutional and individual investors to fund student loans and student loan refinances.
In some instances one is required to be an accredited investor.
With their more solid credit profiles, investors can expect returns starting as low as 2.66%.
SoFi also offers unemployment protection services, career coaching, entrepreneur support and other services geared towards making their borrowers succeed in their careers and businesses, thus in a way, reducing the credit risk.
Founded by ex-Googlers, Upstart takes more than just a borrower’s credit score in determining their credit risk profile.
They also consider other factors such as:
- Work history
- Academic performance including area of study
- Current income
After this the borrower is assigned a rating based on their FICO score and Upstart’s proprietary scoring algorithm.
This indicates a borrower’s financial ability and their propensity (or lack thereof) to service the loan.
Similar to SoFi, Upstart caters to the student loan consolidation crowd.
According to the site, the average FICO score is 690 for borrowers on the platform, with over 90% of borrowers being college graduates.
To invest in loans on this p2p platform one ought to be an accredited investor with a net worth exceeding $1M for individuals excluding the primary residence. Other requirements include:
- Be a US Citizen
- Be a “US Person” for tax purposes
- Have a Bank account.
You can view the entire eligibility criteria here.
Returns range from 3.69% – 9.45% depending on the loan risk profile.
The Upstart platform allows investors to automatically invest in loans. All one needs to do is fill out their preferred criteria and set a fund allocation. The amount is automatically invested in loans that qualify.
Additionally, investors can opt to invest with an IRA effectively using their p2p lending as a retirement fund.
The minimum one can invest is $100 which can be transferred through credit cards (for first time investments only), ACH Bank transfers, wire transfers, or checks.
Register on Upstart Network Website and make your first p2p lending investment.
Zopa is the p2p lending platform in the UK.
It was founded in 2005 and has so far disbursed more than 800 loans to over 20,000 borrowers. It currently has a 2% share of the personal loans market in the UK; dwarfing other p2p lending platforms there.
The following is the eligibility criteria for borrowers on the platform:
- A good credit history
- At least 20 years old
- 3 years of address history in the UK
- A good income-to-debt ratio
- Have not taken out loans of late.
Zopa subjects borrowers to rigorous credit checks, identity checks as well as thorough risk assessment. After this they are assigned a score ranging from A* – C denoting their credit risk, with A* being good credit.
There is also the “S” denotation for small businesses seeking loans on the platform.
Invest in Loans on Zopa
Unlike most other p2p lending platforms, Zopa uses Automated Loan Selection. What this means for investors is that they only need to set a criteria and terms they are willing to lend at and fund their accounts.
Zopa then matches that criteria to available borrowers and disburses the loans.
Zopa ensures that no single borrower is allocated more than 10 (pounds) of the investor’s money. This provides diversification and reduces the risk on the lender’s loan portfolio.
Zopa has a Provision Fund (currently at $5, 266, 144) that enables lenders to receive their investments back in cases where a borrower default.
The fund is put together from the 1% loan origination fee charged on the platform. It’s an added security feature that shields investors from losses arising from borrower default risk.
The platform charges a 1% annual service fee to lenders on the amounts they lend.
Can I Loan Money: Yes!
P2P lending is one of the most popular alternative investment strategies today. As you can see, you can be the bank and earn some serious passive income.
Commit to trying out at least one of the above p2p lending platforms over the coming weeks. Even if you invest less than $100, you can get a feeling of what it’s like to loan money.
And, most importantly, have fun with it!