Back in the day, if you needed a personal loan to start a business or finance a wedding you had to go through a bank. But in recent years, a new option has appeared and transformed the lending industry. Peer-to-peer lending makes it easy for consumers to secure financing and gives investors another type of asset to add to their portfolios. If youâre interested in investing in something other than stocks, bonds or real estate, check out our guide to becoming an investor in peer-to-peer loans.
Check out our personal loan calculator.
What Is Peer-to-Peer Lending?
Peer-to-peer lending is the borrowing and lending of money through a platform without the help of a bank or another financial institution. Typically, an online company brings together borrowers who need funding and investors who put up cash for loans in exchange for interest payments.
Thanks to peer-to-peer lending, individuals who need extra money can get access to personal loans in a matter of days (or within hours in some cases). Even if they have bad credit scores, they may qualify for interest rates that are lower than what traditional banks might offer them. In the meantime, investors can earn decent returns without having to actively manage their investments.
Who Can Invest in Peer-to-Peer Loans
You donât necessarily have to be a millionaire or an heiress to start investing in peer-to-peer loans. In some cases, youâll need to have an annual gross salary of at least $70,000 or a net worth of at least $250,000. But the rules differ depending on where you live and the site you choose to invest through.
For example, if youâre investing through the website Prosper, you canât invest at all if you reside in Arizona or New Jersey. In total, only people in 30 states can invest through Prosper and only folks in 45 states can invest through its competitor, Lending Club.
Certain sites, like Upstart and Funding Circle, are only open to accredited investors. To be an accredited investor, the SEC says you need to have a net worth above $1 million or an annual salary above $200,000 (unless youâre a company director, an executive officer or youâre part of a general partnership). Other websites that work with personal loan investors include SoFi, Peerform and CircleBack Lending.
Keep in mind that there may be limitations regarding the degree to which you can invest. According to Prosperâs site, if you live in California and youâre spending $2,500 (or less) on Prosper notes, that investment cannot be more than 10% of your net worth. Lending Club has the same restrictions, except that the 10% cap applies to all states.
Choose your risk profile.
Becoming an Investor
If you meet the requirements set by the website you want to invest through (along with any other state or local guidelines), setting up your online profile is a piece of cake. You can invest through a traditional account or an account for your retirement savings, if the site youâre visiting gives you that option.
After you create your account, youâll be able to fill your investment portfolio with different kinds of notes. These notes are parts of loans that youâll have to buy to begin investing. The loans themselves may be whole loans or fractional loans (portions of loans). As borrowers pay off their personal loans, investors get paid a certain amount of money each month.
If you donât want to manually choose notes, you can set up your account so that it automatically picks them for you based on the risk level youâre most comfortable with. Note that there will likely be a minimum threshold that youâll have to meet. With Lending Club and Prosper, you can invest with just $25. With a site like Upstart, you have to be willing to spend at least $100 on a note.
Should I Invest in Peer-to-Peer Loans?
Investing in personal loans may seem like a foreign concept. If youâre eligible to become an investor, however, it might be worth trying.
For one, investing in personal loans isnât that difficult. Online lenders screen potential borrowers and ensure that the loans on their sites abide by their rules. Investors can browse through notes and purchase them.
Thanks to the automatic investing feature that many sites offer, you can sit back and let an online platform manage your investment account for you. That can be a plus if you donât have a lot of free time. Also, by investing through a retirement account, you can prepare for the future and enjoy the tax advantages that come with putting your money into a traditional or Roth IRA.
As investments, personal loans are less risky than stocks. The stock market dips from time to time and thereâs no guarantee that youâll see a return on your investments. By investing in a peer-to-peer loan, you wonât have to deal with so much volatility and youâre more likely to see a positive return. Lending Club investors, for example, have historically had returns between 5.26% and 8.69%.
Related Article: Is Using a Personal Loan to Invest a Smart Move?
But investing in peer-to-peer loans isnât for everyone. The online company youâre investing through might go bankrupt. The folks who take out the loans you invest in might make late payments or stop paying altogether.
All of that means you could lose money. And since these loans are unsecured, you canât repossess anything or do much to recoup your losses.
You can lower your investment risk by investing in different loans. That way, if someone defaults, you can still profit from the loan payments that the other borrowers make. But if you donât have enough loans in your portfolio youâre putting yourself in a riskier predicament.
If youâre looking for a way to add some diversity to your portfolio, investing in peer-to-peer loans might be something to think about. There are plenty of benefits that you can reap with this kind of investment. Before setting up an account, however, itâs important to be aware of the risks youâll be taking on.
Photo credit: Â©iStock.com/bymuratdeniz, Â©iStock.com/M_a_y_a, Â©iStock.com/sirius_r
The post How to Start Investing in Peer-to-Peer Loans appeared first on SmartAsset Blog.