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The Biggest Risk in P2P Lending

There's one risk that is completely ignored by many financial institutions.

Dangerously for savers and investors, this blinkered vision filters through to financial and news websites, and even to professionals who should know better.

This risk is such a huge risk for people saving in savings accounts that most savers are almost guaranteed to see their savings be worth considerably less after just four or five years.

And savings accounts are touted as “low risk”!

We'll take that, thank you!

If you haven't guessed, I'm talking about rising prices – inflation. Inflation is like the government saying that it's going to take, say, 15% of your savings from you every four or five years. And sometimes they hit you with a bigger whack out of the blue (when they print more money).

And yet they still leave you thinking you're richer, because the government then fixes it to make it seem like your account says a higher amount.

Short-term lenders have higher inflation risks

If you P2P lend for shorter periods, it can be difficult to get high enough interest rates to compensate you for inflation risks.

You generally get higher rates for longer loans, whereas you can expect between 2% and 3.5% per year for shorter loans.

That doesn't mean short-term lending is a write-off. If you can't afford to lend for longer, you can still get far better rates than you will get in savings in the bank, most of the time. So you'll probably preserve your wealth far better than someone with an HSBC or Barclays savings account.

And soon we'll have P2P ISAs, which means you can lend tax free. It'll make it easier for more people to beat inflation if they don't have a tax bill too.

Short-term lending doesn't have to be low rate

It's not always the case that short-term lending is low rate. In 2014 alone, Funding Circle, for example, has matched over 800 loans lasting between six months and two years, the majority of which gave lenders an interest rate well over 8%.

P2P lending companies offering short-term property loans can also give you higher interest rates, although you have to be very confident that they're doing a safe job, since these sorts of loans are inherently more risky than other types of loans.

And you have one or two other choices, but none of them are the P2P lending companies that are both lower risk and easy to use. In other words, not good as a closest possible substitute to savings; they require some knowledge and some work.

You've got to hold on…

If you're going for longer, higher-rate P2P loans and you get a lot of bad debts, you could also lose to inflation – and a lot more.

This clearly applies to high-risk P2P lending, but in extreme economic times it could also apply to safer ones.

Take a look at Funding Circle's stress test, for example. It found that in an economic crash and high inflation environment, you would lose to inflation – pretty badly, if you're a taxpayer – if the economy and inflation turned nasty. And you'd be losing to inflation despite still earning 5.5% interest after Funding Circle's fees and after bad debts.

Yet the situation would turn around eventually, provided you haven't taken on too much risk. It just might take you a few extra years of higher rates to get back to where you were.

Typically, you recover ground fast in these situations as inflation decelerates. It's the same with the stock market.

So you've got to hold on.

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