Risk and Reward in Peer-to-Peer Lending
Peer-to-peer lending has seen rapid growth in the last 12 months, as the rates on offer from many lenders are comfortably higher than those available from high street banks. However, as with any form of investment, P2P loans have the potential to lose money as well as create it, and while peer-to-peer investment is increasingly seen as a safe option for savers who want to make a return on their savings, there is still an element of risk involved.
It’s important for anyone considering peer-to-peer lending platforms as an investment option to fully appreciate the risks involved, and in this article we’ll cover the risks and rewards of investing in P2P lending.
Is P2P Risky?
Peer-to-peer lending is as risky as you want it to be. Most platforms give lenders control over whether they put their money in high-risk high-reward products or in safer, less lucrative loans, and lenders can choose a combination of risk and reward that suits them.
Peer-to-peer lending is inherently more of a risk than simply putting money in the bank, because the Financial Services Compensation Scheme (FSCS) that guarantees the first £85,000 you deposit in a bank does not apply to P2P firms. However, this would only kick in if the platform actually went out of business, and since there are many P2P firms with a strong trading history there’s no reason to suspect they’ll go bust any time soon (it’s worth bearing this in mind when investing in a brand-new startup, though).
P2P Cover Mechanisms
Peer-to-peer loans, as with any loan, can occasionally go unpaid. In these situations, different platforms have a variety of mechanisms for compensating investors; up until recently, most offered a “cover fund” that automatically made up for any unpaid loans. However this is not necessarily available on all products, and some lenders are beginning to withdraw their cover funds altogether (Zopa’s “Safeguard” fund is being withdrawn in the near future, for example).
This means that lenders are exposed to the effects of bad debt, so it’s important to spread investments as widely as possible to minimise the impact any missed payments have. Most lenders do this automatically, financing each loan from hundreds of different investors, but some platforms require investors to pick a few loans to invest in. This can heighten the impact of bad debt on their investment, and must be carefully considered before committing.
Risks in the P2P Market
The P2P sector has become the Cinderella of the financial markets; it was once treated with disdain, but in the last few years is coming to be seen as the next big thing. The amount of risk in peer-to-peer lending can vary, but the market as a whole has shown itself to be much more resilient than many early spectators claimed.
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