Is Peer to Peer Lending a Legitimate Investment Program?
Peer to peer lending (P2P) is a method of debt financing that allows an individual to lend money to unrelated persons without using traditional financial intermediary like banks and similar financial institutions. Lending takes place online on websites operated by peer-to-peer lending companies using lending platforms.
The prospect of generating higher interest income than what they would earn from conventional savings and time deposit accounts have lured investors to peer to peer lending.
The system allows the lender to screen borrowers through credit checking tools before approving loan transactions.
There are inherent risks in financing transactions with borrowers who would not have otherwise passed credit checks by regular banks or financing companies.
Peer-to-peer loans are unsecured
and risk of default is quite high for borrowers with negative credit history. A lender can mitigate the risk by spreading his investment among several borrowers. Loans are considered by the government as securities that can be sold or transferred to other lenders.
Peer to peer lending derived its title from earlier practice of social lending, which relied solely on social networks to facilitate loans. This has been replaced by faster and more systematic programs and lending platforms developed by peer-to-peer intermediaries.
Peer-to-peer intermediaries supply the investment platform that brings investors and borrowers together, provide credit models for loans transactions and pricing, verifies borrowers’ identity and background, performs credit check, process borrowers’ payment and forward the payments to the lenders, undertake collection procedure for defaulting borrowers, handle legal compliance, and find new investors and borrowers.
Peer-to-peer intermediaries usually runs its credit check through system-fed information and allows the system to rate potential borrowers based on credit risk. Ratings are then posted on their site to allow lenders to bid for the loan contract. One the contract has been awarded, the peer-to-peer intermediary will then be asked to sign a promissory note before funds are issued.
Peer to peer lending essentially encourages socially conscious investing as lenders support the attempt of borrowers to find relief from high-rate loans and assist in the financial needs of those who are deemed to have positive impact to the community.
Borrowers who have negative credit status or those who lack credit history are drawn to peer to peer lending because if offers a fresh opportunity for obtaining funds. Peer-to-peer intermediaries either decline those applications or otherwise charge higher rates for loan availment.
Not a few investors have joined peer to peer lending because of marketing pitches by peer-to-peer intermediaries on the higher rate of return, while downplaying the potential risks.
It normally takes 3-5 years for loans to mature. Until the end of loan terms, lenders are left with no assurance that the borrower will be able to settle his loan in full. This only means that risk is 100% absorbed by lenders or investors. Peer-to-peer intermediaries lose nothing, they simply gain with every P2P transaction.
Except for the assurance of higher interest yield on the loaned amount, nothing much goes for lenders in terms of recouping their investment.
Is P2P a legitimate investment? Is it even an investment?
Some people have described peer to peer lending as nothing more than gambling, and even less than speculating which can be based on other proven facts. They accuse peer-to-peer intermediaries of feeding untested information to lull the investors into a false sense of security that they are acting wisely and making their investing decisions based on valid and accurate borrowers’ information.
The so-called borrowers’ data are presented to investors in smart-looking applications that emphasize the high-tech nature of P2P transactions, but who gets to check on the accuracy and completeness of credit information encoded on the system?
Defaults are perennial threats in P2P investment platform
Penalties are usually assessed for delayed payments and once the borrower cease paying, more fees and penalties are added until the loan is finally declared to be in default.
The P2P company can then sell the note to a collection agency, or petition a court for a judgement against the defaulting borrower.