Peer to peer lending has been in the UK for around fifteen years, and it is getting popular over time. It is also known as peer to peer lending UK or social lending. It is an alternative to traditional lending options and is designed to remove the middleman or bank. It is a direct approach that brings borrowers and investors to the same platform. P2p lending is carried out through online platforms and proves to be beneficial for borrowers and lenders alike. Lenders can earn high-interest rates in return for loans, while borrowers can get quick access to funds at a relatively low interest rate. P2p platforms make money by charging fees from investors and borrowers.
Before getting over-excited due to the high interest and investing money in p2p loans, you should understand the risks associated with it. In p2p lending, there is no safety guarantee, and you may end up losing money. By understanding the risk, you can take measures to mitigate these risks and can earn better returns.
Let’s look at the risks associated with peer to peer lending.
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The most common reason for losing money on p2p loans is when your borrowers are not able to pay your money back, it is known as credit risk. From all the risks in p2p lending, it is the most significant risk. Most of the p2p loans are unsecured, and when a borrower defaults, there is no security that can be used to compensate for your loss. However, some platforms offer contingency funds that are used to protect you in case of the borrower default and to pay your bad debts. You should keep in mind that if a number of loans go bad simultaneously, the contingency funds will be of no use.
One other thing that you must remember while investing in p2p loans is that the more the interest rate, the higher the risk of default. P2p platforms set interest rates on the basis of credit score, and if the credit score is low, it means there are more chances of defaults. So you should look beyond the interest rate and invest according to your risk appetite.
Always choose a p2p platform that is transparent in statistics and displays bad debts so that investors can judge them and make an infrared decision.
Loan Originator Going Bust
Most of the p2p platforms in the UK act as an aggregator and use professional lending entities known as loan originators. These entities find borrowers and send them to the p2p platforms instead of offering loans themselves. It means when you invest money on such a platform, and you are actually investing money to the originator, which passes your money to the potential borrowers. The same is with the loan repayment process, and borrowers repay the loan to the loan originator, which pays to the lender through the platform. So, in this case, you can see how important a rule a loan originator plays in the lending process. A loan originator is an additional risk in p2p lending, and if it goes out of business, you may lose all your investment.
If you invest all your capital in a single p2p loan, no matter how brilliant a p2p platform is, you can end up losing all your money. This type of risk is also known as concentration risk. You can reduce this risk by splitting your investment across a large number of loans so that if one loan goes wrong, you can still earn profit from the other loans. Diversification is a key to mitigating the risks, so you must always keep your p2p portfolio diversified if you want to make high returns.
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Peer to peer lending platforms is like regular businesses earning money through charging fees from investors and borrowers. They may go out of business when they are not making enough. This risk is known as platform risk. Sometimes a p2p platform goes bankrupt. However, in this case, the platform is responsible for collecting all the debts and settling all the investments, but it can take a long time. You must do research about the platform and choose a well-reputed and highly experienced platform to avoid this type of risk.
Now that you know the risks associated with peer to peer lending, it can be easier for you to take necessary measures to mitigate these risks and make bridging loan a passive source of income.