Why secured P2P lending could be the best place to invest your savings
Banks make money lending your deposits. Unfortunately, they’re not very good at sharing the profits. The top US retail banks also pay the worst interest — an average of just 0.09%. That’s below inflation, so if you’ve got your life savings in a bank account, you’re losing buying power with each passing year.
In response, you might be considering a time deposit (CD), or maybe even investing your money on the stock market. And yes, a CD will pay a few percent more, and the stock market will produce even better returns if — and it’s a big if — you can accept the extra risk. But there is also a third, potentially better, option: secured peer-to-peer (P2P) lending.
P2P lending is a happy medium between two extremes. On the one hand are savings accounts offered by your bank. They’re safe, FDIC-insured, but pay pitiful returns. On the other, is the stock market. You can earn big, but it’s risky and labor-intensive. Secured P2P lending sits in the middle, offering returns of 5–15% but with lower risk than stock market trading.
What is peer-to-peer lending?
P2P lending turns you, the investor, into a loan provider. You lend money to someone who will repay you at a later date plus interest, usually 5–15%, depending on your tolerance for risk. Now, this doesn’t mean you have to advertise yourself as a loan shark. Instead, you simply apply online through one of the numerous P2P lending platforms.
The P2P lending platform functions like AirBnB or Uber. They connect investors with borrowers, but don’t lend money themselves. The platform is the medium through which you browse investments, track performance, and withdraw your earnings. Platforms might also assess the creditworthiness of borrowers, indexing them according to risk, average yield, and loan type so you can make an informed choice.
Since P2P lending began back in 2005, it has since grown to $12.3BN industry in the US alone. A plethora of P2P lending firms have emerged to serve this growing market, adding features like recurring investment orders, IRAs, diversified funds, and even algorithmic investment. Some also maintain a fund to offset losses should borrowers default, which is reassuring if you’re investing in high risk loans.
How is secured peer-to-peer lending different?
Secured P2P lending differs in that borrowers secure their loans with collateral. This reduces the risk to you, the investor, and helps ensure you get the returns you were promised. Collateral varies from property to precious metals and cryptocurrencies. If borrowers fail to repay, or their collateral falls in value, the collateral might be sold to repay you.
Not all collateral is created equal, however. Take property, for example. A house is not a liquid asset. There’s a complex legal process to follow if the borrow defaults, followed by a resale period. You could be waiting months or perhaps years before you recoup your losses. And since swings in the property market are notoriously slow, your capital is at risk if the property’s value falls.
Liquid assets, on the other hand, make great collateral. Think gold, silver, and digital assets like bitcoin or ethereum. They can be readily sold and there is less concern about devaluation. If a house devalues, your capital is at risk. If a digital asset devalues, the platform can sell it instantly to repay you. You might lose a bit of earned interest, but at least you got your principal back and a bit of profit.
What to look for before investing in P2P lending
With a little knowledge and research, you can find a suitable P2P lending platform that provides you healthy returns with very little risk. Here are some pointers:
Choose a secured P2P lending platform
A secured P2P platform mitigates the non-repayment risk, so if a borrower defaults, you’re not left empty-handed. While it’s true that some unsecured lending firms maintain an emergency fund to offset investor losses, these aren’t designed to offset all of your losses — just a portion.
Choose a platform that requires borrowers to overcollateralize
Overcollateralization means the borrower puts up more collateral than the loan is worth. To the borrower, this is called the LTV (loan-to-value) ratio — a measure of how much they can borrow against their collateral. For an investor, the lower the better, since it gives more “wiggle room” should the value fluctuate.
Choose a platform where borrowers stake liquid collateral
Whether it’s gold or bitcoin, liquid assets are easy to sell. This negates two risks: non-repayment and collateral devaluation. Ideally, you want a provider that sells when the borrower defaults or if the collateral’s value falls below a certain threshold — preferably a threshold that preserves your principal and earned interest to date.
Choose a platform that is non-custodial
There will be periods when your funds aren’t on loan, forcing you to trust the platform with your money. If they’re insured, this is okay, but ideally, you want a platform that continually puts your money to work. That could mean paying a yield on your deposits, for example (like we do). That way, you never need worry about downtime or undue custodial risk affecting your income.
Consider a platform with flexible investment options
Ideally, you’ll be able to choose the investment term and interest rate. The platform then simply matches you with someone happy to do business with you. You’ll also want to know how to break off the investment early (if it’s possible), and maybe some flexibility in how your returns are paid.
Traditional P2P lending platforms often adopt the role of banker — assessing borrowers, maintaining protection funds, or insuring against losses. The cost of such mechanisms are passed to you, the customer, through higher fees or smaller returns. However, a P2P lending firm that adopts the above criteria can ditch these mechanisms and pass the savings to you.
At Constant, we’re working hard to meet all of these criteria, all of the time, and while we’re not perfect, we certainly aspire to be. But however you choose to invest your savings, remember that banks don’t have the final say. And unless you do your homework (or pay someone to do it for you), the stock market can be daunting and downright risky. Perhaps it’s worth investing in a secured P2P lending platform instead.
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