Thursday, October 05, 2023
Peer to Peer lending is an alternative investment to the stock market and has it's own set of risks.
Peer to Peer lending can also be used as a stream of passive income to reach financial independence .
We want to show you how what are the risks associated with peer to peer lending.
By reading this article or watching the video you will also learn how you can mitigate those risks to lower the chances of losing money.
When it comes to building passive income for financial independence, you will either have to invest your time or your money upfront.
Peer to Peer lending or P2P is an alternative investment outside of the stock market to invest your money.
If you are unfamiliar with peer to peer lending, it is a way as a consumer to get a personal loan outside of a bank.
Individual investors provide the funds for these loans . Not the banks.
As an investor in peer to peer lending you are investing in consumer debt.
Borrowers are borrowing for common needs like consolidating credit cards, or refinancing or remodeling a kitchen.
As an investor you make money by funding part of a loan or multiple loans.
You decide where you want to place your money based on the risk you are willing to take and your time horizon.
When you invest in a loan, you are buying what is called a note.
Each loan is broken up into multiple notes to spread out the risk to investors.
You can buy notes for as little as $25 and across different loans with different ratings and maturity dates.
However, some platforms require you to have an initial investment of $1000 to get started.
When a payment is made on the note it includes the principal and interest.
Payments are split between the investors who invested in or funded the loan.
There are many peer to peer lending sites for different types of borrowers.
Some of the lending platforms have apps and allow automated investing for passive income.
You also have the ability to set it up as an investment in an IRA to defer taxes and choose your asset allocation to spread out your risks.
The amount of passive income you make by buying these notes is based on the average rate of return of the loans you invest in minus the lending platform's fees.
Additionally, defaults or early payments will effect your average rate of return of investment.
For example say you create a portfolio of notes that give you an average annual rate of return of 12%.
Some of those loans may default or are paid off before the year is up.
Let’s say that drops your expected return now to 6% then you have to take 1% away for the marketplace platform fee.
Your average annual rate of return is now 5%.
This is how you can invest your money to make passive income while choosing what to do with your time.
Invest your money to make money that’s the motto.
Now it would be wrong to not tell you the risks associated with peer to peer lending especially with the shaky times we are going through.
These loans are unsecured. Unsecured means that there is no collateral backing the loan.
If the borrower stops paying, then you are out of your money and cannot seize anything in return.
There is nothing for the investors to take.
Unlike if you default on your mortgage or car payment. The bank can take your house or car as collateral.
In other words, if they don’t pay, then their credit may take a hit and they will go to collections but that’s basically it.
Once they stop paying, you are most likely not getting your money back.
Since unsecured loans can be risky, the interest rates paid on peer to peer platforms are higher.
The loans are also given grades based on multiple factors like creditworthiness, what the money will be used for, default probability, etc.
The loans range from 6% - 36%.
The higher the interest rate the higher the risk.
When looking to make passive income for financial independence through peer to peer lending, you accept more risks for a higher rate of return than you would get with safer investments or your bank account.
However, don’t think that the lending platforms are just letting anyone obtain for a loan.
Each borrower has to hit a number of requirements before they can borrow the money.
Some borrowers do default on the loans though so you can be left holding the bag.
Now that you know the background and the risks, how exactly do you get started in peer to peer lending for passive income?
You can get started with peer to peer lending with as little as $25, but to make it worthwhile you should start with $1000.
That way you can buy notes across different grades of loans.
To achieve financial independence you have to be smart with your money and use it wisely. So don’t lose it on risky bets.
Our suggestion is to risk money you are not going to miss.
Spread that money around different loans if you choose to start peer to peer lending.
This way you aren’t putting all your eggs in one basket and are lowering your risk.
Remember, all investing involves risks.
It is up to you to have an honest conversation with yourself about what risks you are willing to take on.
We are a bit more conservative in our investing style.
Peer to Peer lending doesn’t fit right now in our portfolios but it may in the future.
If you feel comfortable investing in peer to peer lending then that is completely fine. Everyone's risk tolerance is different.
Each peer to peer platform we mentioned earlier focuses on a different type of borrower and purpose.
For instance, most of the Lending Club's borrowers are using the loans for refinancing. As opposed to most borrowers on Upstart who use that platform to consolidate debt to pay off credit cards.
While Street Shares loans go to funding Veteran Owned Businesses.
The point is that there are a lot of choices for your investment so you can choose which one is a better fit for your investment purposes.
If you have another passive income investment option you want us to discuss, put it in the comments below,
We believe Financial Independence is attainable for everyone.
You just have to find the right passive income combinations that work for you and go for it.
The Wealth Twins
Our mission is to eliminate frustration when it comes to finding out how to use your money in the best ways possible to meet your goals.