Peer-to-peer business lending or known as P2P is a type of crowdfunding start-up financing. It can be considered as a business loan even though there are differences based on the standards. P2P is borrowing money from a collection of individuals where a peer-to-peer lending institution will facilitate the arrangement. However, the process is that you will step into the door of the lender and apply. The lender will not give you the money upfront but will facilitate the operation of the crowdfunding.
The lender will bring people together or any company that is willing to lend their money to those who need a loan.
How does peer-to-peer lending work?
For a borrower, a peer-to-peer lending facility is just like applying to any other business loan provider. The lender that will facilitate the process will be asking about your profits, business history, bank account statements and your plans to the money that you will borrow.
If you pass the criteria and requirements, your loan application will be open to the interested investors. The investors offer small amounts that will collectively add up to the total figure you want to borrow. The process is handled differently depending on the lending institution. Some use an auction-style to bid an interest rate. Others will set the rates and wait for investors to come and choose the loan if they want to invest. If all goes well, your funding will be acquired faster.
Peer-to-peer business lending is a relatively new concept in its form. The power of the internet has made it possible for any person to lend or borrow money without any help from the bank. Borrowers would likely prefer P2P as a good option because you do not have to comply with several underwriting procedures like the traditional bank does. No credit checking, lesser fees, and possibly lower rates.
Getting started for Peer-to-peer business lending
1. Open an account with a P2P lender institution to lead the process. You may also be asked to pay some amount by debit card or direct transfer
2. Set the interest rate you would like to receive.
3. Lend an amount of money for a fixed period
Some institution has an “auto bid” feature where you can set limits on how much you want to lend in each borrower and the interest rate you want.
Can I make money from peer-to-peer business lending?
The money you make will depend on how much you incest and type of loan. Borrowers that are considered to qualify as lesser risk will have lower interest rates compared to borrowers that have not such a good debt payment history.
The peer-to-peer platform will grade the borrowers based on their debt history, type of loans availed and the amount they want to borrow. If you want a steady income and with minimal risk, you can invest to borrowers with solid credit history. However, if you wish to profit that is on the rise, you may opt the borrowers with an interest rate of more than 20%. It means that the higher the risk, the higher will be your reward.
Is it safe to invest in peer-to-peer business lending?
Just any other investment it can always be safe because of safeguards established. However, no investment is guaranteed to profit every single year. The assurance of earning a profit with P2P is when you invest in borrowers with proper credit. Though good borrowers enjoy a low interest rate which you will receive, you will be assured to stabilize your earnings.
The strategic way to earn from P2P is investing in multiple borrowers. For example, you have $5,000 ready to invest, and someone applied for $5,000, you can choose to invest $50. This way, you can mitigate the risk for the particular loan if in case it goes default.
There is available loan screener that can help you find borrowers that pass your criteria. The platform will also guide you to know the average default rate for the borrower grade. The tool can help you come up with an informed decision.
What are the risks?
No business is running without any risks. Any risks go along with good reward.
1. Risk of getting credit default
The person borrowing might not be able to pay the credit. However, the screener tool can help manage the risk. The higher the default rate, the higher the number of people that may not be able to pay back. The Financial Services Compensation Scheme do not cover the money lent via P2P website compared to the banks. That is why there are tools that will help you come up with an informed decision.
Also, the P2P websites have contingency or provision funds that are purposely designed to pay out if a borrower goes credit default. However, contingency funds vary from one site to another. If you want to be a lender through P2P, know what the pre-conditions are and cover before you commit your money
2. The risk or early or late repayment
If the loan is paid early or late, you make less profit. However, if the credit is paid soon, the advantage is you can roll-over again the money by directly lending out again.
3. Risk of the P2P site going bust
Since the business is through online-presence, there is a higher risk for the website to shut down. You need to know that the Financial Conduct Authority in the UK is regulating the P2P lenders. It is a policy that the lender’s money should be kept separate accounts from the account of the company.
4. P2P lending and tax
The money you earned is taxable. However, because of the personal saving allowance policy which allows basic rate taxpayers to make up to £1,000 for tax-free interest. Any interest earned above your allowance is paid at your marginal rate of tax. The Innovative Finance ISA (IFISA) allow P2P loans to be deposited in an individual saving account (ISA). The interest you receive from P2P loans will be tax-free. Also, you don’t need to declare any ISA interest, income or capital gain to HM Revenue and Customs.