There’s really no denying it – there ARE drawbacks to peer to peer lending. In fact, there are probably as much risks as there are benefits to this investment solution, which is normal in almost any kind of business venture. But what any experienced businessman will tell you is that knowing these risks is half the battle. And if you play your cards right, you’ll benefit more from P2P lending than you would be set back by it.
But as stated, knowing the risks of peer to peer lending is half the battle. So here goes:
Borrowers can Default on their Loans
If there was a list of all the risks, this would probably be on top. This is a concern specific to peer to peer lending because most loans there will be unsecured. No kind of collateral like a house or car is attached to that loan, which means that borrowers don’t really put too much at risk, lowering their incentive to pay back.
Now this doesn’t mean that no one will pay back their loans. In fact, chances are most of them will. But you will have to be open to the possibility that some of them will not. In fact, you may not have experienced peer to peer lending in full if you’ve never experienced a borrower that defaults.
What most investors do is they distribute the risk they undertake by investing in different loans. That way, the chances of you losing everything to a defaulting borrower is cut into as many loans you distribute your money around.
So to emphasize, this is the biggest risk. If you’re not ready to take on this one risk, maybe you shouldn’t consider peer to peer lending at all.
Your Platform Might Underwrite Poorly
This problem is not as bad as borrowers defaulting because it’s based around the circumstances of the platform you’re transacting with. But it IS still a considerable risk because when you’re relying solely on the website to underwrite loans, you ultimately have no hand at deciding which borrowers you are exposed to.
So when you’ve got borrowers getting investments that they probably shouldn’t be getting, the chances of default rates going up could also increase, which causes problems for everyone.
The solution to this problem is no different, however, is no different from the last one. Diversifying your peer to peer lending accounts to say, somewhere around 200 loans is a good way to shield yourself against poor diversification of investors. The logic is that if borrowers themselves can’t be allocated properly, then maybe you should re-allocate your account instead.
This solution doesn’t really mean you’ll have to shell out more because you could always work with the minimum capital (around $10,000 to $5,000) and split the amount. It’s that simple.
When it comes to peer to peer lending, splitting your risks is perhaps the most practical way of mitigating them. As long as you’re working with a reputable platform, you’re more likely to experience gains than losses.
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