It’s easy to start investing in peer to peer lending and a great way to earn monthly cash with less risk than stocks
I’ve been investing in peer loans for years and am always amazed that more investors haven’t taken advantage of the new asset class. Whether it’s a fear of the unknown or they just don’t think they need the additional return, Main Street investors haven’t yet caught on to the opportunities in p2p investing.
It’s too bad because not only do peer loans provide a higher return than bonds but also lower risk than stocks. Investing through a retirement account on Lending Club also gives you a deduction on your taxes each year and your returns grow tax-free until retirement.
But you’re still not quite sure about the new investment and not ready to start investing in peer lending.
I get it. It took me years to open a p2p account even after several conversations with my cousin about his returns of 12% annually. I used personal loans as a borrower but was not quite sure about how to start investing.
Check out this peer lending investing infographic for why you should include peer loans in your portfolio and some of my favorite criteria for picking loans. Don’t forget to scroll farther down for a complete guide on how to start investing in peer lending including returns you can expect, investment strategies and how to avoid the risks.
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Why You Need to Start Investing in Peer Loans
The investment returns available in peer lending is just part of the reason to start investing. I interviewed an investor last year about his experience investing on Lending Club. Jeff has been investing in peer loans for nearly a decade and has made over $10,000 on returns that averaged 12% a year.
That kind of return is impressive considering peer lending is a fixed-income investment like bonds. Bond investments to companies with a maturity of five years, comparable to the length of time you’ll hold a p2p investment, are yielding just 2.25% a year. That’s barely above the rate of inflation which means you’re basically just parking your money.
Even the safest category of p2p loans on Lending Club offers a return of 5% annually and less than two in every 100 loans go unpaid.
But it’s not the only reason to start investing in peer lending.
Investing part of your portfolio in peer loans reduces the risk in your total wealth. That’s because the returns on peer loans don’t react the same to the economy as stocks or bonds.
- Peer lending investments aren’t traded on a secondary market so the value of your investment doesn’t rise or fall when interest rates change as with bonds.
- P2P is a shorter-term investment, between three and five years, so inflation won’t affect the payments you receive as much as longer-term bonds.
- P2P loans are an obligation by borrowers to pay rather than a bet on the profits of corporations like in stocks. This means that even if the economy stumbles and corporate earnings fall, peer loans still pay their contractual payments.
Because of the differences between stocks, bonds and peer loans, adding them all together actually reduces the risk in your portfolio. When the stock market crashes, you won’t see your total investment value fall along with it. It’s this fact that makes peer lending one of my favorite ways to invest right now.
A lot of investors still ask me about loan defaults and how to avoid making investments on bad loans.
My answer…Don’t worry about it. Loan defaults are just a part of investing in P2P or any bond investment for that matter. Even the bonds of huge corporations sometimes go unpaid.
The percentage of unpaid peer loans is fairly steady for each risk category, meaning about the same number of loans default each year. In the safest category of loans, it’s less than two loans in 100 while the riskier categories see as many as ten loans in 100 default.
The graphic below shows the average interest rate charged on Lending Club loans and the investor return for each risk category. As the risk increases, so does the return even after accounting for higher loan defaults.
There are ways to minimize defaults even within each loan category by selecting loans with specific criteria and we’ll get into that soon. The best way to invest in peer loans though is to make sure you always have at least 100 loans in your portfolio. That means if a few loans default, you’ll still have many more paying off.
How to Start Peer to Peer Lending Investing
Getting started investing in peer lending is easy and open to everyone. In fact, right now Lending Club is offering bonus cash up to $3,000 when you open an IRA retirement account.
I recommend investors use the retirement account option when p2p investing. Otherwise the interest you receive on loans is counted as income each year and taxed. If you invest through a retirement account on Lending Club, you pay no taxes on your investment and can even write off each year’s investment as a tax deduction.
To start investing in p2p loans, click through the link above and fill out your contact information. The entire application takes less than five minutes and you can fund your account with an automatic transfer, wire or check. You need to be at least 18 years old and have a social security number, but that’s it.
There is no minimum to get started on Lending Club but I suggest you invest at least $2,000 if possible. This will allow you to invest in almost 100 loans with $25 each to get that instant diversification.
My Favorite P2P Loan Criteria to Start Investing
I know several investors that just invest across all loans on Lending Club. They pick their loan categories in which to invest or just put their money in any loan available. You wouldn’t invest in stocks that way but, surprisingly, that kind of dart board approach is still an acceptable way to invest in peer lending.
Investing in all loans or all loans in a specific category is going to give you the average returns and default rates in those loans. That means about a 7% return across all loans and a default rate of about eight loans in 100.
A better strategy though is to selectively pick loans that match different criteria. Just by investing selectively on a few filters, I have been able to boost my portfolio return several points from the average.
Lending Club makes this easy with a simple filter screen where you can select only the loans that match your criteria.
The best filter I’ve found is the Debt-to-Income (DTI), the amount of payments a borrower makes on debt divided by their total monthly income. A borrower that has more money available after paying debt each month isn’t likely to default on their loan so I like to set this one for less than 20% of income. Just this p2p investing filter alone boosts my returns over 10% and lowers the number of defaults.
Another great filter to use when starting peer lending investing is Inquiries in Last 12 Months. This is the number of times the borrower has applied for credit over the last year and a good way to make sure they aren’t scrambling for cash. It’s ok if they’ve applied for credit a couple of times but I like to set this filter for 3-or-less. Using this filter alone will boost your returns slightly and lower defaults.
A borrower with a long Employment History generally is going to have more job security and is less likely to default on their p2p loan. I usually set this filter to 10 years or more at their job. It doesn’t boost return much but it does help to limit loan defaults in your portfolio.
The table below includes three additional loan criteria you might want to check out as you start investing in peer loans. The data was calculated at a different time than the infographic so the exact numbers may not match up because returns and defaults vary with time.
|P2P Investing Criteria||Description||Return on P2P Loans||Average Interest Rate on Loans||Average Loss on Defaults|
|All Loans||All P2P loans available on Lending Club||7.2%||13.4%||6.4%|
|Debt-to-Income Ratio < 20% (Joint)||Total monthly debt payments relative to income for joint account loans||10.8%||13.6%||2.3%|
|Joint Application||Loan application filled out by borrower and cosigned by another||10.6%||14.4%||3.3%|
|Inquiries Last Year < 4||Borrower has applied for credit three times or less in last 12 months||8.3%||12.3%||3.4%|
|Accounts Opened Past 24 Months < 4||Borrower has opened three or fewer credit accounts in last two years||8.2%||12.6%||4.6%|
|Employment > 10 Years||Borrower has been employed for 10 years or longer||7.9%||13.5%||5.8%|
|Annual Income > $75,000||Borrower has annual income greater than $75,00||7.7%||13.0%||5.5%|
How to Invest in Peer to Peer Lending for Cash Every Month
One of the biggest benefits to p2p investing is that it pays out cash every month. The loans in which you invest will make monthly payments of interest and principal. Instead of having to wait years to sell your stocks for a return, peer loans provide cash every month and can be a great way to cover expenses in retirement.
While you will fund your account when you start investing in peer loans, you will want to deposit money regularly when you can. You can set your account to automatically invest money in loans that meet your criteria or check in each month to do it yourself.
This means you will always be investing in new loans with deposits and as payments come in on old loans. As old loans get paid off, you will have new loans take their place and will have a continuous source of cash flow.
Just like stocks and bonds, investing in peer lending can be customized to fit your need for return and tolerance for risk. I usually recommend one of three strategies for investors depending on what they want out of their peer loan portfolio.
|Type of Investor||Best Lending Club Loan Categories||P2P Loan Criteria||Expected P2P Investing Return|
|Needs reliable income, low risk||A, B||Home owners, income verified, debt-to-income <20%||6.5%||Click to Start Investing|
|Reinvest money but does not want much risk||B, C, D||Mix 36- and 60-month loans, no delinquencies, home owners, DTI < 30%||8.5%||Click to Start Investing|
|Long-term and wants to maximize returns||D, E||60-month loans, no delinquencies, DTI < 30%||10.5%||Click to Start Investing|
The investor that wants the least amount of risk but still wants to get consistent cash flow every month should stick with loans from categories A and B. These are the very best borrowers with credit scores well over 750 on average. You might also filter the loans for home owners with verified income and a debt-to-income of 20% or less. These borrowers aren’t going to default on a small loan and destroy their credit so loan payments will be consistent and you’ll get around 6.5% return on your money.
Investors that want a little more return and are ready to take on a little more risk in their peer lending portfolio can invest in the middle categories for risk (B, C and D). These are still fairly good credit borrowers and you should be able to book an 8.5% return annually.
Long-term investors that are able to take on more risk can reach for double-digit returns with this last strategy. Lending Club keeps strict lending requirements so even the borrowers in the D and E categories usually have prime credit scores above 600 FICO. You will have higher defaults in this strategy but your returns will still be higher because the interest paid on loans is around 18% and higher. Manage the defaults by only investing on loans where the borrower has no defaults and a debt-to-income of 30% or less.
I don’t usually invest in the riskiest F,G categories of loans. Defaults can get so high that it starts to eat away at returns and the total return is about the same as the other categories.
Best P2P Lending Sites to Start Loan Investing
I invest on Lending Club and recommend it to all new peer lending investors. The website is open to investors in all states except Ohio but those in Pennsylvania, North Carolina, Alaska and New Mexico will have to open an account on FolioFn to invest.
Check out this complete Lending Club review to learn how to invest in peer lending
Lending Club is the world’s largest peer lending platform with more than $24 billion in loans but there are other p2p sites available to investors. Prosper Marketplace is currently the only other peer lending site available to non-accredited investors, those with net wealth below $1 million or an income of less than $200,000 annually. If you are an accredited investor, you may be able to start investing on other peer lending sites like Upstart, SoFi and StreetShares.
Whichever website you choose to start investing in p2p loans, make sure fees are no more than 1% of your investment and you can filter loans by different criteria. The option to automatically invest in loans that meet your criteria is a great tool and takes all the work out of the investment as well.
3 Risks in Peer to Peer Lending Investment
I’ve covered the risks in peer lending investing before on the blog but wanted to highlight them again in this post. Most investors are surprised to find that the risks in p2p are basically the same you’ll find in any other investment including stocks and bonds.
- Investing for higher returns without understanding your risk tolerance
- Not investing in enough loans for diversification
- Investing for the short-term and selling your loans
Avoiding these three risks in peer lending will ensure that you achieve those higher returns and meet your investing goals without the stress that comes with bad investing behaviors.
As I highlighted in the three p2p investing strategies, your tolerance for ups and downs in your portfolio will determine the loans in which you should invest. If you’re the kind of person that freaks out over even the smallest decline in your investments, you wouldn’t rush out to invest in penny stocks. You also wouldn’t invest in the riskiest categories of peer loans which can see 10 or 20 loans default in every 100 loans.
Investors that don’t like risk should stick with the first three categories (A, B and C) of loans and be happy with returns that are still way above that of bonds.
You absolutely must hold more than 75 loans in your portfolio though I usually suggest at least 100 to 150 loans. You can invest as little as $25 in each loan so that means less than $2,000 to get started investing. Do this and invest equal amounts in each loan and you won’t have to worry about unpaid loans.
Even borrowers that don’t make all their loan payments will pay for a few months and some of the loans that go to collection will pay off as well. That means you will lose less than 1% on loans that default while those that pay off will return 10% and higher depending on the category.
Finally, don’t worry about having your money locked into a loan for three or five years. If you are investing regularly then you will always have loans paying off and be receiving monthly payments. Is three or five years really that long to hold an investment? Don’t be like most stock investors that buy and sell their investments quickly, missing out on higher returns and paying thousands in fees.
Getting started investing in peer lending is an easy process and one of the best ways to diversify your portfolio. You can only invest in peer loans through specific websites like Lending Club so take advantage of their cash back offer to open a retirement account. You’ll get the returns of stocks with the relative safety of bonds in an investment that provides monthly cash. Let me know if you have any questions but don’t wait. Start investing in p2p loans today and profit from the new asset class.