What is peer-to-peer lending? Are you better off just investing your money elsewhere?

Peer-to-Peer lending is a way of lending your money direct to people who need loans, cutting out the banks and money lenders in between. It is a technology dependent investment product and is one of the most interesting developments for smaller inventors in recent years.

The aim is not just to lend you money to someone who needs a loan – that would be pretty risky, because if the loan defaults, your money is gone. The technology behind peer-to-Peer lending is what makes it really interesting.

There are two general types of Peer-to-Peer loans:

One where the lender is matched up with someone needing a loan, or chooses the lender themselves from a list. Avoid these types of Peer-to-Peer loans, you cannot mitigate the financial risks lending money this way.

The second type is far more interesting. These use auto-investing technology to spread your money across many different loans. This means only £10 – £20 of your money is invested in each loan, (you don’t want all your eggs in one basket) so the actual loan is an aggregate of money from many investors.

The other great thing about an autor-investor, is whenever interest or loan parts are repaid, the auto-investor makes sure that money is immediately invested in new loans. There is nothing worse than investment money sitting round uninvested.

Now, as is the way with loans, some default – this is a fact of life. When this happens, you may lose all or part of your money invested in that loan (most Peer-to-peer platforms use debt collectors to pursue defaulters through the courts). It is the job of the Peer-to-Peer platform to manage credit ratings and credit checks, and control to whom your money is lent. This ensures defaults are kept to a minimum – this is why you pay them a percentage of your profits. But even if you lose all your money in that loan, you have only lost £10 – £20 of your investment, and the profit from all the other loans should still provide you with a reasonable rate of return.

Essentially, a Peer-to-Peer to platform is acting just like any other bank, making money from loans. The difference, is you can open a Peer-to-Peer account with as little as £100, meaning even small investors can get in on the act and make money directly from lending. To do this with a traditional bank, you would need hundreds of thousands, which is why only the rich and well off have traditionally made money this way.

Interest rates from Peer-to-Peer loans, after fees and defaults, range from 3% to 12% depending on who you lend to, what level of access to your money you require, whether you invest in personal or business loans, what type of loans are being lent (personal, business, property, bridging etc) and what risk categories you select.

Granted, you will not get rich overnight with Peer-to-Peer loans, but as part of a smaller investor’s financial strategy, they are a solid way to earn more than a typical savings account.

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