One of the side effects of the atrocious market we have endured in recent months is incredibly low interest rates on deposit accounts. Bank savings accounts are earning less than 1% yield, and even traditionally higher online savings accounts at the best online banks, such as ING Direct, are only offering 2.75% APY (at the time of this writing). What’s a conservative-leaning investor to do?
If you are up for taking on slightly more risk for the chance of a lot more reward, the peer-to-peer lending industry might be the place for you. I was admittedly skeptical when peer-to-peer lenders first came on the scene, but the more I’ve learned about the industry, the more I appreciate its ability to cut out the middle man (banks).
What is Peer to Peer Lending?
Peer-to-Peer lending involves investors pooling their money to fund loans for borrowers in the private market. Interest rates vary according to the credit risk for a particular borrower, but it isn’t uncommon for investors to earn over 6% or 7% on loans for those with good credit, and much more on riskier borrowing prospects.
One of the aspects of peer-to-peer lending that appeals most to me is the fact that banks are cut out of the lending cycle and power is pushed down to the average citizen. Perhaps it appeals to my entrepreneurial spirit. I might not be able to fully fund your $10,000 debt consolidation loan, but I can pitch in $100 along with dozens of other investors. This helps spread the risk around a bit so that no single investor is heavily leveraged in any one loan deal. It also provides borrowers greater opportunity for receiving a loan in this tightening credit market.
Borrowers are asked to fill out a profile including a compelling description indicating the reason they are in need of a loan. This has a way of personalizing the request. Perusing the current loan listings at Lending Club I see a variety of loan requests from debt consolidation, to a used car purchase, to a request for start-up capital to fund a new business idea. Knowing that you are investing in someone’s dream is exciting!
Peer-to-peer lenders, such as Lending Club, also grade borrowers based on their creditworthiness including such factors as debt-to-income ratio, credit scores, etc. Of course, it isn’t foolproof, and there are risks of defaults and late payments, particularly when peer to peer lending to borrowers with bad credit. However, several well-placed investments in loans could make for a portfolio producing a much higher yield than other types of cash investments.
How Much to Invest in Peer-to-Peer Lending?
I personally treat this type of investing much the same way I treat single-stock investing; I don’t put more than 10% of my overall portfolio in either investment. The bulk of my investing is for retirement inside growth stock mutual funds. Outside of retirement funds I stash emergency fund cash away in an online savings account, and with any remaining cash I may dabble in things like peer-to-peer lending or investing in single stocks I feel good about over the long-term, and have a history of producing great dividends.
So like anything else I recommend here, don’t dump all your eggs in one basket. Start small until you get the hang of social lending.
Interested in finding out more about social lending? Join me over at Lending Club!