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How safe is P2P lending?

Posted on 01/10/2018, by Joe Jones

Whether you’re investing in the stock market, crowdfunding or bonds, all investment comes with some form of risk. And peer-to-peer lending (P2P) is no different.

It’s gained a lot of popularity as a way to put your money to work, without the ups and downs of the stock market. But, while some forms of P2P investing won’t expose you to the volatility that comes with equities, it’s still important that you’re aware of the risks you’re taking on.

A borrower may not be able to repay the loan

One of the biggest risks you take on when investing in peer-to-peer loans is that the borrower may be unable to repay the money that you lent them. This could be for a number of different reasons, such as losing their job or some other change in circumstances.

You therefore need to be confident that the loans you’re putting your money into are being made to creditable borrowers, who are likely to make the repayments.

One way to mitigate this risk is to invest in property-backed loans. These provide a layer of security as, if the borrower can’t repay the loan, the property can be sold to try fund the debt.

However, this doesn’t mean your investment is risk free, as…

The value of the secured asset could go down

While secured loans offer a degree of risk mitigation, it is possible that, should the property need to be sold, it doesn’t recover enough funds to repay the lenders in full.

It’s why it’s important that you check the nature of the loans you’re investing in. In particular, the loan-to-value ratio (LTV). A loan with a lower LTV will be less risky, as it means that the value of the asset would have to fall by a greater amount before you’re at risk of losing any money.

Let’s use Octopus Choice as an example. The maximum LTV of the loans we make is 76% (although, our average is actually 61%). This means that the value of a property would have to fall by up to 24% before you’d be at risk of losing any money.

A borrower could be late with their loan repayments

If a borrower is unable to make their repayments on time, then it may be that you don’t get paid your interest until they catch up. While you’ll hopefully still get the money you’re owed, it may mean that you won’t have access to it until that time.

Your money could be tied up for some time

Some P2P lending platforms will have no fixed-term, meaning you can request a withdrawal at any time – sometimes for free. However, you should know that instant access isn’t always going to be guaranteed.

Before the provider can withdraw your money, they’ll usually have to sell your loans to another investor, or you’ll need to sell your loans yourself on the secondary market if they have one.

Alternatively, if some of the loans have had difficulties being paid back, you might not be able to access this money until they’re back on track – or, if the borrower can’t pay back, until the asset has been sold.

Not all P2P is the same

Ultimately, the amount of risk you take on depends on which provider you use, and the quality of the underwriting of the loans. After all, every P2P lender is different. So it’s a matter of doing your research, being clear about who it is you’re investing with and who the loans are made to – here at Octopus Choice we aim to be as transparent as possible, by making details of the loans in our portfolio publically available on our Statistics page.

However, for those worried about the risks, it may be that peer-to-peer lending just isn’t for you. Why not check out our blog on the top 7 questions you should ask yourself before investing in P2P lending.