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4-Step Strategy to Safe Peer-to-Peer Lending
Safe peer-to-peer lending is not as risky as the stock market. Not by a long shot.
However, as with the stock market, the risks in P2P lending are not uniform. Some lenders will lose a lot of money over the next half century, simply because they don't have a plan or do no research.
That said, the risks in P2P can be reduced to a very low level with a simple, sensible strategy.
At the same time, the probable returns increase with a sensible plan, because lenders who focus on containing the risks get better results in the long run.
The four steps in brief
1. Spread your money across 100s or 1,000s of loans
You wouldn't buy just one share on the stock market with all your savings. (We hope!)
Lending all your money to one borrower is also a highly risky thing to do. Imagine if a bank manager did that? She'd get fired from head office right away.
To give ballpark figures based on 4thWay analysis, say you lend all your money to just one ordinary individual borrower just before a recession hits. You have maybe a 10% chance of losing three-quarters of all your money. But lend to 100 people and the chance of losing most of your money falls to less than 0.0000001%.
You should aim to spread all the money you put into P2P across hundreds or thousands of borrowers.
Many P2P lending companies make this easy by automating your lending. Some split your money between lots of borrowers without any action from you.
2. Commit to re-lending and then exiting “naturally” through borrower repayments
The stock market is so rocky that you can't even be confident of coming out well over 10 years. That's why it's a very long-term investment.
Peer-to-peer lending, like bank lending, is lower risk, because it's easier to predict what might go wrong with a basket of borrowers in a recession, and set interest rates accordingly.
4thWay's bank modelling shows huge resilience, with both 4thWay's models and the P2P market having been seriously tested several times.
This resilience is especially strong if you commit to a minimum period of time. So we're confident that regular lending and re-lending of repayments and interest will see the vast majority of people come out fine.
This has already also been demonstrated since 2005 – through two recessions and a property crash. Almost all lenders with sensible strategies have made money every year, but certainly well within five years they have done so.
4thWay's specialists recommend you lend and re-lend your repayments and interest for at least two years.
When it comes to exiting your loans, be prepared to wait until borrowers repay naturally, with interest. That's the normal investing period when doing money lending.
If you aren't prepared to do that, you might have to try to sell your loans early at a time when this is difficult. In some cases, you might be able to exit early, but only by selling your loans to other lenders for a cut price.
3. Spread your money between six or more P2P lending providers
We've found that a minority of long-term 4thWay users lend through just one or two lending accounts, when you should be using six or more different providers if you want to properly minimise the risks to a very low level.
The vast majority of us should stick to the P2P lending companies that take multiple steps to protect your money. Go for super-prime borrowers. Lend your money against property that is valued much, much higher than the loan that is taken out.
Providers often have other defences which contribute to earning 4thWay PLUS Ratings. These things, which are weighed mathematically using international banking standards when our specialists calculate their ratings, include:
- The type of lending.
- The results of each historical loan.
- The interest rates.
- Whether pots of money are set aside to pay expected bad debts.
- The P2P lending company or its directors promise to take the first loss on all loans.
- Partner companies agree to buy back bad debts.
- The quality of any security offered by borrowers to back up loans, such as their properties.
- The length and breadth of the provider's history.
- And many other items.
4. Keep an eye on rising risks
By following the above three points, you can expect to come out with satisfactory rewards, even if you have to suffer extra bad debts due to a recession similar to 2008.
However, while the P2P lending companies you use today might have extraordinarily good borrowers and defences against losses, that won't always be the case for all of them. For some of them, cracks will start to show or their standards will slip.
This has already happened. A couple of P2P lending companies lost their 4thWay PLUS Ratings or “buy-tip” status from 4thWay's specialists, which gave our users plenty of time to get out. Over a year later, these companies went under in complete and total disgrace.
Many, many other providers failed to be rated or get buy-tip status in the first place, as their apparent good work was plastering over a lot of weaknesses.
So watch very closely for warning signs that their standards are slipping and get out when you no longer recognise it as the safe company you first lent your money through.
These warning signs can include such things as late payments rising much faster than other P2P lending websites, many more loan applications being accepted, bad-debt provision funds shrinking fast, or interest rates getting lower and lower.
Not all the best P2P lending companies will retain their great 4thWay PLUS Ratings forever and subscribers to our email will be first to know when any of them are slipping.
This was part five of our ten-page P2P lending guide
Read part four: The 13 Key Peer-To-Peer Lending Risks.
Read part six: 10 Ways To Get Your P2P Lending Money Back!
See the contents of the whole 10-part guide.
Independent opinion: 4thWay will help you to identify your options and narrow down your choices. We suggest what you could do, but we won't tell you what to do or where to lend; the decision is yours. We are responsible for the accuracy and quality of the information we provide, but not for any decision you make based on it. The material is for general information and education purposes only.
We are not financial, legal or tax advisors, which means that we don't offer advice or recommendations based on your circumstances and goals.
The opinions expressed are those of the author(s) and not held by 4thWay. 4thWay is not regulated by ESMA or the FCA. All the specialists and researchers who conduct research and write articles for 4thWay are subject to 4thWay's Editorial Code of Practice. For more, please see 4thWay's terms and conditions.
The 4thWay® PLUS Ratings are calculations developed by professional risk modellers (someone who models risks for the banks), experienced investors and a debt specialist from one of the major consultancy firms. They measure the interest you earn against the risk of suffering losses from borrowers being unable to repay their loans in scenarios up to a serious recession and a major property crash. The ratings assume you spread your money across hundreds or thousands of loans, and continue lending until all your loans are repaid. They assume you lend across 6-12 rated P2P lending accounts or IFISAs, and measure your overall performance across all of them, not against individual performances.
The 4thWay PLUS Ratings are calculated using objective criteria that can be measured and improved on over time, although no rating system is perfect. Read more about the 4thWay® PLUS Ratings.