The social sharing economy has revolutionized the way you – the average person – make money in ways very few people envisioned a decade ago! Don’t believe me? Think about Uber, Airbnb, or the tv show Shark Tank; none of these platforms existed before 2008 – 10 years ago. Another concept that was just getting started a decade ago was investing in P2P loans.
As the Internet continues to redefine the ways we make money, P2P investing has become a popular source of passive income. Instead of investing in a CD or bond that generates a small interest payment, you can be the banker and lend directly to borrowers and earn a higher yield.
Whether you want to diversify your investment portfolio, start a side hustle, or eventually replace your full-time income, peer lending can provide a stable monthly income with minimal time commitment, even in 2018.
Even if you can only start with $1,000, you can still build a well-diversified portfolio to limit volatility.
What Is P2P Lending?
If you’ve only heard the term P2P lending, here’s a quick refresher.
In the traditional banking world, potential borrowers submit a loan application to finance a car purchase, house, or to refinance credit card debt. To avoid all those bank fees nobody likes to pay, P2P loans offer the same financing with fewer fees and a potentially lower interest rate.
As a P2P lender, you invest in shares of their loan and collect interest from the payment. Because you are “the bank,” you collect a more significant percentage of the interest payment instead of only receiving 1% interest.
How to Make Money from P2P Lending—The Right Way
Depending on your investment strategy, P2P lending can be an excellent alternative to low-interest CD and bond investments because of the higher potential yield and less risky than stock investments.
Like any investment, it can be as risky as you make it. When it comes to stock investments, you can choose a blue-chip dividend stalwart with a stable growth history or a volatile penny stock with cyclical gains and losses.
With P2P loans, you can invest in borrowers with good credit ratings and bad credit ratings. The riskier the borrower, the more you interest you earn if they make their payments. If they miss a payment or default on the loan, you lose the remaining balance.
After a historic year for the stock market in 2017, you might be looking to rebalance your investment portfolio and move some of your assets out of the market to avoid volatility.
A successful P2P investing strategy can help you earn a 7% average return each year after charge-offs and late payments are accounted for. Considering the average stock market investor only earned 2.3% on average from 2003 to 2013, the potential upside of P2P lending is even more enticing.
Note from Rob: Personally, I’ve only made about 2% returns from P2P sites like LendingClub. However, if you spend time to select your loans, it is possible to earn higher returns. It’s just important to do your research first. Personally, I like the Real Estate investment tools better.
P2P Loans Can Also Let You Invest in Real Estate
P2P loans are also an excellent way to build a real estate empire without being a landlord or having large amounts of financial capital.
You can crowdfund residential and commercial projects and let the experts do all of the heavy lifting. And, we all need a roof over our head to sleep at night and work in the daytime – so these investments are pretty secure!
If you currently own rental property or want to, you know that real estate investing requires lots of time and financial capital. When you still have a mortgage of your own to pay off or you don’t have enough zeros in your bank account (yet), owning real estate remains a dream.
While you should always perform your due diligence with an investment, you don’t have to be the property manager fixing a water leak at 2 am or trying to find new tenants to fill unoccupied space.
With P2P real estate loans, you can get started with an investment for as little as $100. Eventually, you can roll these gains into larger projects. Just like you built your stock market portfolio from scratch, your real estate portfolio can grow in the same manner.
Some popular sites for P2P real estate investing include:
- AHPFund (any investor): $100 minimum
- Fundrise (any investor): $500 minimum
- RealtyShares (accredited investors only): $1,000 minimum
- EquityMultiple (accredited investors only): $1,000 minimum
Like P2P personal loans, you can expect an average real estate return between 8% and 12%, which is higher than the average stock or REIT returns, because once again, you are investing directly in a project.
What are the P2P Lending Risks?
Even though many peer loan investors earn positive returns, they do have borrowers of all credit backgrounds that default or miss payments. There are risks with any investment, even “safe” investments, and that’s why it’s so important to diversify.
For P2P loans to be a good idea, avoid the following habits:
- Chasing yield and only investing in high-risk investors
- Investing all your money only in one or two loans
- Not researching the borrower’s background or reason for the loan
- Assuming every loan will have a positive yield
Just like a bank can issue a personal loan for any purpose from buying a boat, remodeling a house, or consolidating debt, peer loans can be unrestricted as well.
Only invest in loans that are for causes you believe in. If you wouldn’t lend the money to yourself if you were in the borrower’s shoes, don’t lend the money. It’s that simple.
Is P2P Lending a Good Idea?
If the idea of being a direct lender doesn’t scare you away, then P2P loans are a great alternative to your current investment strategy.
Investing in the stock market isn’t the only way to invest and outpace inflation. Plus, you don’t have to worry about the potential fluctuation in the market value of a stock price which can be $100 today and drop 20% in one day if they miss earnings estimates or a scandal is revealed.
You can also start small with your investments until you find your rhythm or you have more financial capital to invest.
And if you’re not ready to put your money entirely in CD ladders or bonds, you can outperform the bank by becoming the bank.
Josh Patoka writes for MyStockMarketBasics and PeerFinance 101. When he isn’t trying to generate passive income from a well-diversified portfolio, he teaches teenagers valuable life lessons.