In recent years you have likely heard about investing in peer-to-peer lending. That is what is known as P2P or collaborative lending. It is an interesting form of investment and financing, but it is not without some risks and keys to understanding.
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What is P2P financing?
The first thing to understand is that there is no single P2P financing model. The market is opening up more and more to new ideas and models. Understanding this is important as we will find a diverse market, with many variations and wide options.
To understand the scope of the different types of financing, we will mention just a few:
- Crowdfunding: in which individuals or entities financially support a project or cause. Generally, the investor’s reward has to do with the project itself. For example, when someone finances the release of a music album and, in return, gets a signed copy or special edition.
- Crowdlending: in which individuals or entities invest in the financing of companies or business projects. There are different formulas. They can range from participation in the shareholding to an agreed reward in the form of interest at the loan’s maturity.
- P2P: direct loans between individuals. These platforms connect users who want financing with others who wish to invest. In this case, a return is obtained based on the financed’s interest to the financer.
These are just a few examples, and in this case, we will focus on the latter, on platforms that allow financing or investing for third parties.
How P2P financing works
How peer-to-peer lending on the internet works is simple. It is based on Internet platforms where those seeking financing offer their conditions, generally linked to the platform’s standard templates.
These platforms perform risk analyses. Depending on the risk analysis, the interest rate offered by the financed party is higher or lower. It can also raise or lower the interest provided to the investor to attract a larger volume of investors.
The investor accesses the platform and can usually determine his risk profile through simple questionnaires. That allows him to select better the loans in which to invest. However, it is not mandatory, in short, it is possible to interact with all or a large part of the offer.
Once you have selected the loan or loans you wish to invest in, you can obtain information about both the project or need that requires financing and the applicant. The support process is simple and fast.
Most platforms block the money until the total amount requested is obtained. In fact, in many cases, if the desired financing is not accepted, the process is reversed, and the investor gets the full amount without any loss.
Once the loan has been initiated, the established terms and repayment periods are fulfilled.
Advantages of investing in P2P lending
The main advantage that this investment model can offer is that the expected return is significantly higher than that of other conventional financial products.
On the other hand, cooperatives are simple. It is enough to know a little about the basic functioning of financial services on the Internet to operate. In addition, it is not necessary to contribute large amounts. From $50 or $100, it is already possible to invest in many loans.
It is also interesting to note that the platforms dedicated to intermediating in this type of loan have made great progress in security and risk analysis in recent years. In many cases, they offer tools such as repurchase guarantee or default insurance, although these are tools with an added cost.
Risks of investing in P2P loans
The main risk of this type of investment is the default. As in the conventional lending industry, peer-to-peer lending has a default and delinquency rate.
However, you should note that this rate is even lower than that of traditional financing tools.
The platforms recommend diversification to minimize the default risk: do not put all the money in a single investment.
Another risk to be considered is unprofessional platforms or those with security flaws. While it is true that this has been decreasing over time, selecting the right platform is a basic task if you want to get it right with this type of investment.
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