I haven’t talked much about my peer to peer lending activities, mostly because I’m still in the evaluation stage and I’m only one year into it. But peer to peer lending through organizations like Lending Club ^[2] have gained a lot of popularity in recent years. I have made some paper profits from person to person loans, though I haven’t invested all that much yet (a little less than $1,000).

^[2] The main thing to consider is that you literally ARE becoming a bank. You are lending your own money to people you know only from an application. You could lose money. You should diversify. You have to think like a banker.

When I do invest ^[3], I consider several factors and you might consider adopting these if you decide to become a lender yourself:

First, I never invest (or lend) money I can’t afford to lose.

These person to person loans are not like a CD at a bank – they aren’t guaranteed and are not secured loans – so I don’t invest ^[3] the kid’s college money or my emergency fund ^[4] in them. Those investments are reserved for traditional (or online) banks such as ING Direct ^[5], Ally Bank ^[6], or another online bank ^[7].

^[8]

Second, I never invest (or lend) money I’ll need anytime soon.

Peer to peer lending sites ^[2] typically allow loans to be repaid to investors over the course of three years, sometimes longer. Your money isn’t readily available from the lending site, but you can possibly sell your loan on the open market. Chances are pretty good you’ll take a hit, so to avoid that loss, I make peer to peer lending investments with “play money.”

Third, I factor in the fees when calculating my returns.

Prosper lenders pay a 0.5% to 1% annual servicing fee, based on the balance of the loan outstanding. Lending Club ^[2] charges 1% of all payments received each month. If one of my loans goes to collections, I know I’m responsible for the collection agency’s fees. Those fees can take a bite out of your potential returns.

Fourth, I think like a bank.

Having been a banker for 5 years, I’m aware of the dangers of lending to people with varying degrees of credit worthiness. I also make certain I understand the logistics of each peer to peer lending site, whether Prosper or Lending Club ^[2]. Lower credit grades DO command higher interest rates, but the risk of losing is also higher. So, when picking borrowers, it helps to think like a bank. I make sure I diversify among different borrowers and different credit grades. For example, if I had another $1,000 to lend, I would split that among 10 or 20 borrowers. Of course, $50 per loan may sound like small potatoes, but that’s exactly how most peer to peer loans get funded – a little at a time from a wide variety of investors. I would also diversify among credit grades by putting 20 percent of my money into a higher risk category, 30 percent into medium risk, and 50 percent into lower risk borrowers who are paying the lowest rates.

Peer to peer lending is a great option

For investors, it allows us to capture a little better return than those offered through traditional banking channels, albeit at a higher risk. For borrowers, person to person lending allows them to acquire cash at a lower rate than through a traditional banking channel. In short, we’re cutting out the middle man.

What factors in peer to peer lending do you think are important?

About the author

Ron has written 1082 articles on The Wisdom Journal.

The founder and editor of The Wisdom Journal ^[15] in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a partner in a national building materials company.

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