P2P, or Peer To Peer Lending is emerging as a strong alternate investment asset option for new investors today. The model always existed at local level in informal ways, but it is the recent penetration of smart phones and advanced technology which has made it possible to reach the masses and crystalize as an asset class accessible to all.
Parking money in fixed deposit at banks is no longer lucrative, many may argue, with many investment options promising handsome returns. In fact, inflation alone ensures that we lose money when we leave it in banks. Clearly this is not what we aim for when we seek to grow our income to achieve financial freedom. One of the recent emerging high return investments is P2P Lending.
P2P lending stands for Peer to Peer Lending. It helps individuals to borrow and lend money. It is rapidly gaining popularity since it opens up access to credit for millions of credit starved Indians – from salaried professionals to small businessmen. P2P Lending platforms connect borrowers with individual lenders, who come together to crowdfund the borrowers’ loan requirements. While borrowers get loan at attractive interest rates, these rates are also great for lenders as these are 2 to 3 times the interest rates on fixed deposits etc. It’s a win-win for both borrowers and lenders!
Peer-to-peer lending achieves this by eradicating the middlemen which are typically banks. Banks get deposits from retail customers at about 4% and then provide personal loans at say 16% – 20%. They keep the margin. On the other hand, P2P Lending platforms will make available all interest to lenders and charge nominal service fee. They allow lenders to have a highly diversified portfolio which mitigates the risks associated with loan defaults. For example, typical loan default is 2-4% in personal loans. Accounting for these, overall returns is still 16% – 25% which is very attractive. What’s more, you can start investing with an amount as low as Rs. 5,000.
Let’s look into some other reasons which makes P2P lending an attractive option to make money.
#1 – Higher interest rates
Any investment makes sense if it is able to provide great returns without too much risk. P2P lending suits this perfectly when compared to popular investment class such as fixed deposit, mutual funds etc.
- Fixed deposits provide returns between 6-8%, while saving bank accounts yield about 4-6%.
- Mutual funds on an average can provide a return up to 9-16% in long term (i.e. invested for more than seven years to avoid the impact from short term market fluctuations).
- In comparison, P2P investments have less volatility and higher returns. They can provide returns in 16% – 25% p.a. range. An investor can select returns depending on his risk appetite.
#2 – P2P lending is regulated
In India, P2P lending platforms are classified as non-banking financial companies and are being regulated by the RBI. unlike other avenues of investments – such as cryptocurrencies. The investment and returns can also be audited.
#3 – Easy and 100% Hasslefree
Leading P2P Lending platforms readily provide the risk – return profiles of each loan helping the investors make simple and easy decisions. Also, the process is hassle free and investment can be made at the click of mouse, similar to purchasing stocks or mutual funds. The whole process is digital, auditable and fully transparent.
#4 – Focus on High Quality Loans
Loans tend to be thoroughly scrutinized on 50+ parameters, including CIBIL score. Borrowers’ credit history as well as digital footprint is meticulously analysed on several parameters such as financial capacity, repayment intent, social media score, relationship with peers etc. Physical verification is also undertaken in most of the cases to doubly ensure quality.
In an unfortunate case of default, platforms may also provide recovery and collection services as well. They also provide principal protection which may help the investors recover their capital.
#5 – Risk diversification
P2P lending works best when lenders diversify risk by lending small sum of money to multiple borrowers in different risk category and varying loan purpose. Let’s show it with numbers:
- When you invest Rs. 2,000 each across 50 borrowers, and if one of them defaults – you’re looking at a loss of Rs. 2,000. Let us assume you make 20% returns on the remaining 49 borrowers. Hence, net gain is about 18%.
- Contrast this with a scenario where you invest the same money into just two borrowers. In the case of a default, you’d be staring at a loss of Rs 50,000 straight!
P2P lending loans help diversify risks of an existing investment portfolio of bonds or stocks. For example, when your stocks are trading in the red, you need not worry because your P2P investment will still deliver steady returns, lowering the impact of losses from other investments. This is possible because it does not have much impact due to everyday market volatilities.
#6 – Additional monthly income
Since the loan is repaid by the borrowers in the form of EMIs, P2P lending adds to your monthly income. Think of it like a second salary. Unlike other investments, where you typically receive the principal+interest at the end of your lock-in period, or when you cash out, P2P lending help you get a stream of monthly cashflows from the very next month you have invested. In addition, returns are not subject to market risks as with the equity sector.
#7 – Reinvest to benefit from compounding interest
Einstein once said, compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. Investors should re-invest their monthly cashflows in fresh loans to enjoy the benefit of compounding.
#8 – Protection against Inflation
In an inflationary economy, you will enjoy higher interest rates, thus there is an inbuilt protection against inflation.
P2P lending delivers multiple benefits of high interests, low volatility, and diversified risks bundled into one. A disciplined investment strategy should result in safe, flexible and profitable investment.
