Lending money involves some risk. However, there are ways to minimize the risks. Since peer-to-peer lending is a relatively new arena, the following are several effective ways to protect yourself to ensure that you get your money back. Of course, with peer-to-peer and the right investment company, you get your money back with interest.
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Understand the Platform
It is crucial to understand how the online peer-to-peer investment company works prior to lending money on the platform. As an investor, you should know how the money is being lent on the platform and what the risks are.
Make sure to ask the P2P company for details such as the recovery process and returns for your money. You can perform your research or communicate with the P2P company via emails, chats, and phone calls.
Diversification is a critical step that lenders must take to minimize the risk. As a lender, you need to examine if the platform provides a diversity of borrowers for investment. It is always better to spread your funds across different types and risk rates. A good number will be 100 different loans. Investing in tiny amounts across a massive number of loans will likely keep the default rate at a low level. Thus, it will increase your returns. Diversified lenders have hardly lost money on P2P lending sites. It provides lenders with a risk-adjusted return of up to 18%.
You must check how strong the risk team of your investment company is. Who is running the risk department? It is crucial to communicate with them. It is ideal if the risk team is composed of people with a solid track record in risk management and practice. The team that handles data science within the organization should be responsible for producing analysis to enhance the quality of the decision-making. Currently, not many peer-to-peer lenders publish data and statistics about the loans. But long-term players who are serious in this field do so for additional transparency in the system and build lender confidence.
If there is no insurance for the borrower and some unforeseen situations such as accidents, sickness, or death happen, the lender is vulnerable to a significant risk.
To mitigate this from happening, collaborations with life insurance companies will aid borrowers in getting insurance to protect themselves from default in case of accidents. Payment to the closest relative should happen on the regulations set out by the platform. An approval from the P2P lending company is needed prior to the payout.
The Risk of Foreclosure and Early Repayment
A borrower repaying the loan prior to the time will result in a lender not receiving the estimated interest.
There is no penalty for this. But some peer-to-peer lending platforms will be charging a minimum of three months’ interest if the borrower decides to pay in the first two months. So, there should be some flat fee even after three months.
Macro risks that impact the economy are beyond the control of the lending platform. These aspects include recession, political turmoil, and natural disasters. It can affect the borrower’s ability to make repayments.
To mitigate this risk, the lender and the borrower must clarify that they have an agreement. The lender has the right to collect what is due at any point in the future once the country has recovered from, for example, a natural disaster or a recession. During that interim, the P2P platform should constantly communicate with the borrower and get updates about their status.
P2P lending is an incredible investment opportunity where the return on investment is high. There are ways to mitigate risk as long as you invest smartly.