Blog Invest What Are The Risks Of Peer to Peer Lending?

What Are The Risks Of Peer to Peer Lending?

date October 6, 2020 time 6 min read 1498 views

If you’re seeking loans or want to invest in P2P lending, it’s crucial to know the risks to avoid being caught off-guard by unpleasant surprises. The risks of peer-to-peer lending can be loosely classified into investor, borrower, and platform risks. Here’s what you should know about P2P risk management before getting started.

While P2P lending today is often a less risky way to get a decent return on investment today, it has had a spotty history. There are many horror stories on the internet about people losing money to scheming platforms and untrustworthy borrowers.

Fortunately, with a little bit of risk assessment, many issues traditionally plaguing these products can be easily avoided. Here are some of the key peer-to-peer lending risks you should be aware of today whether you are a borrower or an investor.

What are peer to peer lending risks and business models
Like and financial tool, peer to peer lending has its share of risks (source: p2pmarketdata.com)

The business models and their risks in P2P lending

There are over 200 P2P lending platforms in the world today, but they’re not all the same. P2P platforms can be broken down into two categories: unsecured and secured.

Unsecured

Until recently, most P2P lenders were unsecured platforms. This means, if you applied for a loan the platform mostly looked at your credit score to determine if you were a good candidate. The problem though, is that even if people had good credit scores there was still a risk of defaulting — which did happen. 

Secured

Fortunately, with the rise of cryptocurrency, secured P2P lending has become a more appealing avenue. In this case, borrowers put up cryptocurrency as collateral (sometimes up to twice as much as the loan amount). That way, if the borrower defaults, the platform can immediately liquidate the crypto to pay back the investors. This practice has resulted in better interest rates for borrowers and greater confidence for investors. 

The peer to peer lending business model takes risk off the platform and puts it on borrowers and investors
The peer to peer lending business model takes risk off the platform and puts it on borrowers and investors (source: jeangalea.com)

Risks of P2P lending for borrowers

Credit risk

If your P2P platform doesn’t accept crypto as collateral, then there’s a good chance that the platform will have a look at your credit score. 

While most platforms will make a soft inquiry (which has no impact on your credit score) it’s not uncommon for P2P platforms to make a hard credit check — especially if you’re having trouble paying back a loan. A hard check will sometimes affect your score and will stay visible for two years. Make sure to read into a new platform before you begin to see what sort of check they make. 

Besides damage from hard checks, you need to make sure you repay on a P2P platform just like on a traditional loan. Similar to taking a loan on a credit card and not repaying, if you fail to repay a P2P loan, your credit score will take a severe hit. 

If your credit score is poor, it’s best that you try to improve your score first before taking out an unsecured loan. Your interest rate will be better and you won’t risk a hard inquiry into your credit history. You may also want to look into secured P2P loans.

Collateral risk

Collateral risk is simply the likelihood of losing your collateral when taking out a secured loan.

If you borrow against collateral with a secured P2P loan and you default or are late with repayments, the P2P platform may sell your assets to repay investors. If the value of the collateral drops (a common risk in crypto-backed loans) the cryptocurrency may also be liquidated to cover any losses incurred. 

Putting up collateral may not seem appealing to borrowers, but this practice has resulted in a greater level of trust from investors and much lower interest rates for borrowers. When researching secured P2P platforms, make sure they have systems in place to help you prevent liquidation.

Risks of P2P lending for investors

Money drag

One risk you may experience as a P2P investor is ‘money drag’ or the time it takes for your investment to be matched with a borrower.

Once you deposit money in a P2P platform and start lending, interest is only earned after you’re matched. It may take a few days or weeks for you to be matched with the right borrower and your money may remain in limbo during this time. Make sure you review the loan process of each platform if this is a concern for you.

Interest risk

Interest risk has two forms:

1. You may invest in a fixed-rate long term loan at one rate only to have the market rate rise above what you are earning during the loan. 

2. Inversely, if you invest on a platform with variable interest rates, you might suddenly start earning less in a market slump.

Generally to avoid these risks you’ll want to invest on platforms with high loan liquidity. Meaning they make it easy to get money out of a loan should you become dissatisfied with the rates. Always check to see if your platform offers a secondary market.

Default risk

The most common risk in P2P is late repayments from borrowers or defaults. This may result in losing both your principal and interest depending on how platforms manage the risk.

Some peer to peer lending risk management you can practice to avoid these situations include:

  • Assessing the type of lender you are investing in. For example, is it a corporate or individual loan? What is the purpose of the loan? Corporate loans generally have a lower risk compared to personal loans because corporations risk more if they default.
  • Checking for collateral. Secured loans have a higher chance of recovering your money should the loan go bad.
  • Diversifying your investment across different loans with different risk levels. Interest rates on many P2P platforms range from 7- 36% depending on risk. Higher interest rates mean higher risk. So, you can hedge high levels of risk by investing a small portion of your money in high-risk loans and the majority in medium and low-risk loans. If possible, you should diversify your investment across different platforms.
Is p2p lending a good investment today? If you understand the risks, it may be
Is p2p lending a good investment today? If you understand the risks, it may be (source: europeanbusinessreview.com)

Platform risks in P2P lending

Bankruptcy

Though there are dozens of established P2P platforms out there today, the P2P industry is still relatively new. When selecting your platform, it pays to do some research on newer platforms as there is a risk of them going bankrupt. If such a situation happens, there may be delays in getting your money back, or you may lose everything.

Account security

Like any other financial institution, P2P platforms also face the threat of hacking. Make sure they use proper encryption techniques and offer you options like 2FA for greater account security. Some platforms, like MyConstant, use 3rd-party asset custodians to hold funds and help spread out risk.

How to assess risk on a P2P platform

  • How many years of experience does the platform have? An experienced team will be able to identify credit-worthy borrowers as well as manage loans. Check for online reviews from customers to get a feeling for the platform.
  • How transparent is the P2P platform? For example, how much information is accessible on their website? Have they put out their default rate? Do they display their interest rates and fees? Are there client testimonials displayed on their page? 
  • Does the platform follow appropriate security measures? Are funds on the platform safe? Is the web page encrypted? Do they provide 2FA options for you account?

Try peer-to-peer lending with MyConstant, a platform designed to minimize risk and maximize profit

Secure P2P lending at Constant
Experience secure P2P lending at MyConstant (source: moneysmylife.com)

We think we have a unique answer to P2P lending risks on our platform and we think you might be interested.

All loans on MyConstant are backed with collateral worth 150% of the loan value, protecting our lenders against borrower defaults. And you don’t need to worry about money drag because we match you instantly. While unmatched you earn an automatic 4% APY with any time free withdrawals.

For borrowers, We store collateral in either a cold wallet or a password-protected web wallet with our third-party custodian until you repay. And if the value of your crypto falls, we allow top-ups from native crypto wallets to avoid liquidation. You can also use multiple collaterals to back loans and even earn interest on your idle cryptos.

All lending is protected against hacking and cybercrime. All accounts work with Google and email 2FA. If you want to see what the future of risk management in P2P looks like.

Come check us out. Sign-ups are free.

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George Schooling

George Schooling

Borrow against your multi-crypto portfolio in minutes from just 6% APR

Tags: peer to peer lending risks is p2p lending a good investment peer to peer lending risk management peer to peer lending opportunities risks of peer to peer lending

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