P2P Beginners: What Are the Risks in Peer to Peer Lending?
This is the third in our mini-guide series for P2P beginners. This week we address peer to peer lending risks, what they are and how P2P lending platforms mitigate these risks. Links to previous mini-guides contained bottom of page.
Investing in peer to peer lending (P2P), like any form of investing, is not risk free. The most common risk in P2P is that the borrower you lend to defaults on their loan, can’t repay the debt owed, and you lose money as a result.
P2P lending is not covered by the Financial Services Compensation Scheme (FSCS), unlike banks, therefore your money is at risk.
To protect your investment, the P2P lending platform should have strict criteria and due diligence processes in place to ensure quality borrowers are approved onto the platform. Security, such as property, may be taken over the loan to further limit risk, and recovery procedures laid out so that in the event of a borrower default, the platform has steps to follow to recover the money you lent.
There are no guarantees, however, so here are some of the primary risks associated with peer to peer lending:
Peer to Peer Lending Risks
- Platforms conducting poor due diligence
Platforms have teams responsible for vetting the borrowers they approve onto the platform. If their criteria and vetting procedures are not robust, or they stray into riskier borrower groups, or the security they take is not of sufficient value, this can increase the risk of borrower default and investors losing money.
- Large number of borrower defaults
P2P platforms will often spread your money across a large base of borrowers, therefore an occasional default should not drastically impact your investment. If a large number of borrowers default simultaneously, perhaps due to economic stress such as a rise in unemployment rates, this could negatively impact your investment.
- Access to funds
P2P lending is not considered a particularly “liquid” asset class, i.e, transforming your loan into cash by selling it to another investor is not a guarantee. Fortunately, for the more established platforms, enabling access to your money is not such a big issue.
- Platform insolvency
There is a risk that platforms collapse, particularly the newer less established ones. This could negatively impact your investment. Platforms are, however, legally mandated to have procedures in place if this event does occur.
- Lack of diversification
While many platforms automatically spread your money across multiple borrower for you, other platforms require you to select your own loans, therefore you’re responsible for your own diversification.
We polled our users and asked them to select the THREE main risks they consider when investing in P2P lending, here are the results: