Peer-to-peer lending can offer inflation-beating returns but you need to be aware of the risks – here is how you can manage them.
There is no such thing as a safe investment but there are steps P2P investors can take to ensure they are accessing the asset class in the safest and most sensible way possible.
Investors already have to complete classification and appropriateness tests to show they understand the risks and start putting their money onto a P2P lending platform but there are extra steps you can take.
Here is what else P2P investors could be doing.
Make a plan
As with any sort of investing, it is important to know what your goals are.
This can help you decide on how much risk you want to take, the type of products and how long you can or should put your money away for.
“The first step to successful investing is figuring out your goals and risk tolerance,” says crowd bonds provider Crowd for Angels. “It is important to keep in mind that there is no guarantee that you’ll make money from your investments.”
Make use of your ISA allowance
P2P lenders typically offer a classic general investment account but many will offer Innovative Finance ISAs (IFISAs.)
These tax wrappers form part of your annual ISA allowance, which is currently £20,000.
This is money that can be earned tax free so it may be more beneficial to opt for an IFISA first when investing in P2P loans so you benefit from tax-free returns.
Don’t forget your emergency fund
It is important to maintain an emergency fund.
This can help cover unforeseen events such as home repairs or if you lose your job.
Experts at Money Helper suggest keeping three months’ worth of expenses in a separate savings account to cover you for any emergencies.
Make sure any money you are putting into P2P lending, or any investment, isn’t reducing your emergency fund.
Read more: What IFAs want from P2P platforms
Be aware of P2P lending risks
There are a few unique risks to P2P lending.
There is no Financial Service Compensation Scheme protection, unlike with other regulated products.
That means there is no guarantee that your money will be returned if a P2P lending platform goes bust, but this extra risk for investors is also reflected in higher rates compared with savings accounts.
Similarly, most lenders will have plans in place to chase late or defaulted loans, but there is no guarantee if or when they will get the money back.
This may mean waiting longer for repayments on your investment.
Many platforms will have secondary markets where you can sell loans to access your money early.
This isn’t guaranteed though as it depends if there is someone else to buy them. So don’t rely on this if you will need to get your money quickly.
A common rule of investing is not to put all your eggs in one basket.
The same applies to P2P lending.
Investors should consider spreading money across different P2P lenders and also among different assets such as shares and bonds.
Diversification protects you if some assets are going through a bad patch as other uncorrelated investments could make up for the losses.
Not all P2P lenders are the same and make sure you know what you are investing in and can access information you need to make a decision.
You can back a variety of loans including property, consumer and business finance.
Check which type of loan best suits your risk profile.
Some loans may be secured on a property while other platforms may have a secondary market, which could provide some reassurance.
Beyond the type of loans, also consider how a platform has performed.
All P2P lenders are supposed to make their loan performance and arrears and default forecasts available.
This can help you assess how risky the underlying loans are and the type of performance you can expect.
“Treat buried information as if there’s a reason, missing or ambiguous information as if it contains bad news, and decreased information as if it contains worse news,” guidance from P2P analysis and ratings firm 4th Way says.
“Demand more verifiable information the less that is provided freely.”