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A few weeks ago, we wrote an epic post explaining everything you need to know about Peer to Peer Lending. We gave an amazing outline of what peer to peer lending is and how it works, for both investors and borrowers. But today, we are going to focus entirely on Investing with Peer to Peer lending.
Investing with Peer to Peer Lending
Is Peer to Peer Lending a Good Investment?
The most important question about investing with peer to peer lending is whether or not it’s a good investment. That’s a tough question to answer, and has a lot of variables. The better question is whether it’s a good investment for you.
If you are a beginner investor, I’d say no, it’s not a good investment for you. Check out our amazing Beginner’s Guide to Investing for some better options. In the same vein, if you only have a small amount of money to invest, Peer to Peer investing isn’t the best place to put it. Check out this post on Vanguard’s Total Market Fund for an idea of where you should put your money if you don’t have a lot to invest.
When is it a Good Investment?
You might be thinking that investing with peer to peer lending is a bad idea after I warned newer investors away. But that’s not the case. It’s not a bad investment, and it’s not a scam.
Peer to Peer lending is a great idea for experienced investors looking to diversify away from stocks. It’s also a great idea for people with a little bit of extra money to invest who want to help others out.
Can you Make Money with Peer to Peer Lending?
The point of any investment is to make money, right? So of course you can make money with peer to peer lending. Some investors have boasted about returns of over 10% – though I don’t think that’s typical.
Keep in mind that just like any investment, there is risk involved. There might be years with negative returns, or even years with positive returns that don’t beat the stock market. I’ve heard tale of those 10% returns, but my returns have been between 2-3%. That is better than returns on a traditional savings account, but way worse than returns on my Vanguard ETF.
What is the Risk?
The risk with peer to peer lending is that borrowers default. Some of the people who borrow on peer to peer lending platforms do so because they don’t have a lot of other borrowing options, or they have maxed out on their credit cards. They may be higher risk for defaulting than borrowers seeking loans through traditional lending sources. The interest rates reflect the level of risk, so you have higher returns – if the borrow doesn’t default.
Over the course of the past few years, returns on peer to peer lending investments have been lower than stock market returns. Of course, past performance is no guarantee of future results, so it’s possible that could change at any time, especially with a recession looming. Nobody knows which sectors will be hit the worst by the next recession, so diversification is always a good idea.
What is the Best Peer to Peer Lending Site for Investors?
Lots of blog posts will list quite a few sites for investing with peer to peer lending, but after doing tons of research I realized that there are really only two good options. The most well known is Lending Club, but Prosper is also a great choice.
Lending Club had a much better marketing team. I always thought it was the original peer to peer lending platform, but as it turns out Prosper started a year before it did. Lending Club boasts returns of between 4 and 7 percent on their website, while Prosper advertises average returns of 5.1%.
The platforms are fairly similar. They both give you the option to either chose your own notes or set up automatic investing. In my opinion, automatic investing is better because you can set it an forget it. When I first used Lending Club, I didn’t set up automatic investing, and then I forgot about my account for a few years. When I finally remembered and logged back in, my money was just sitting there doing nothing. Set it and forget it can be nice sometimes.
The only advantage I can see to one over the other is that Lending Club is available in more states. For a full comparison between the two platforms, check out this awesome post by Investor Junkie.
There are some other investment options that are similar to Peer to Peer lending, and are sometimes confused with it. The three platforms that are most often confused with peer to peer lending platforms are PeerStreet, Street Shares, and Upstart. All of these platforms are great, they just aren’t actually peer to peer lending, even though they are listed as such on tons of blog posts.
Peerstreet is a great for those looking to invest in real estate. Streetshares is very similar to Peer to Peer lending, but it’s specifically for business loans for Veteran owned businesses (and I’m a huge fan of this idea, as a veteran myself!). Upstart isn’t even for investors, it’s a lending institution for people who may not be able to get good interest rates from traditional lenders. I don’t actually know how it gets included on most lists for peer to peer lending options, but since it’s there a lot I thought it would be best to include it.
All three of these platforms are great, and they have their advantages, but they aren’t technically peer to peer lending.
How Do I Invest with Peer to Peer Lending?
Investing with peer to peer lending is easy, depending on your state. Some states don’t allow their residents to invest with peer to peer lending, so you’re going to be out of luck if you live in certain states. Check out this handy map to find out if your state allows you to invest with peer to peer lending.
Once you find out that you’re allowed to invest in your state, it’s as simple as setting up an account and choosing your notes. Let’s use Prosper as an example.
Investing with Prosper
If you want to set up a peer to peer investment account with Prosper, first click here to go to the homepage, and click on “invest” in the upper right-hand corner. Next, Prosper is going to ask you whether you want to open an IRA with them or a general investment account. There are pros and cons to each – the IRA is tax deferred and specific to retirement, whereas the general investment account is taxable and there are no penalties for withdrawal at any time.
After deciding what type of account that you want, Prosper will ask you for your personal and tax information, like any bank or investment firm. Once you give them all the information they need, you can start browsing notes and decide which ones you want to invest in. You can also set up automatic investing using their handy tool. It’s super easy!
Disadvantages to Investing with Peer to Peer Lending
Like any investment, Peer to Peer Lending has it’s disadvantages. The first is that interest rates are little lower than you would get in a traditional ETF. Another disadvantage is that when borrowers default, that money is just gone. It’s not like if a company’s stock is down, it can go up again. It’s more like when a company goes out of business and you lose the entire investment. That’s why it’s great to use the micro-investing tool, and only put a small amount of money into each loan. This way, if one or two of the loans you funded go into default, you will still make positive returns on the ones that didn’t.
Another common complaint about peer to peer lending is that both of the platforms allow institutional investors to gobble up loans. This is great for borrowers, because they have more opportunities for their loans to be funded. It’s not so great for investors, because the big guys chose the best loans with the lowest risk. That leaves the small individual investors with less options. However, if one of your reasons for choosing to invest with peer to peer lending is to help out some people who need it, this isn’t much of a detriment.
Is Peer to Peer Lending a Good Investment Option for You?
Peer to Peer Lending is a great investment for someone who wants to diversify and help others while gaining a little bit of passive income. If that’s you, sign up for either Prosper or Lending Club today.
Melanie launched Partners in Fire in 2017 to document her quest for financial independence with a mix of finance, fun, and solving the world’s problems. She’s self educated in personal finance and passionate about fighting systematic problems that prevent others from achieving their own financial goals. She also loves travel, anthropology, gaming and her cats.