:max_bytes(150000):strip_icc()/GettyImages-539440276-9803acfd45044b5f834958197e745218.jpg "How I’m Talking to Clients About Peer-to-Peer Lending")
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Key Takeaways
- P2P lending may offer better returns than traditional fixed income but comes with credit, liquidity, and platform risks.
- Diversifying across many notes and assessing borrower credit quality helps manage default risk.
- P2P loans are hard to sell before maturity and may require discounts.
- Returns rely heavily on the platform’s integrity, fees, and loan servicing.
- P2P lending should be a small, diversified supplement based on clients’ risk tolerance and time horizon.
Clients seeking fixed income or diversification may see Peer-to-Peer (P2P) lending as a valuable option. P2P lending is online lending that connects borrowers directly with individual investors, bypassing traditional banks. Compared to conventional savings accounts and CDs, P2P lending offers the potential for higher returns for investors, but also introduces risk.
How P2P Lending Works
Online marketplaces host loan listings, perform credit checks, and assign interest rates based on risk. Borrowers include individuals or small businesses seeking loans for debt consolidation, medical expenses, or business needs. Investors can fund part or all of a loan, diversifying across many notes to manage risk. Lifecycle-wise, a borrower applies, the platform rates risk and structures terms, and after funding, borrowers repay principal and interest to investors over time.
What I’m Telling My Clients
Potential Benefits
Historically, P2P yields have been higher than those of traditional fixed-income options, reflecting borrower risk and platform fees. By investing in multiple notes across various credit grades and sectors, you may incur a diversity risk.
P2P lending can expose you to a higher yield for fixed income vs. traditional savings and CDs. Within person-to-person lending, spreading notes across credit grades and sectors stabilizes returns, smooths income, captures niche yield, and reduces single-borrower and cycle risk. These advantages often harder to achieve with traditional bank products concentrated in fewer options, but are protected by the bank.
Important
Over the next few years, the U.S. Peer-to-Peer Lending market is projected to experience significant growth.
Potential Risks
Borrowers may default, resulting in the loss of principal and interest, with risk levels varying by credit grade and platform screening. P2P loans are also typically illiquid. Selling a note before it matures can be challenging or may require a discount. Platforms are another risk to consider. The platform’s governance, security, and fee structure directly affect returns and access to funds.
Warning
During economic downturns, default rates may increase, negatively impacting performance.
Performing Due Diligence
Assess platform credibility by evaluating track record, regulatory status, custodianship of funds, and user reviews. Review the screening process for borrowers. Understand servicing fees, payout schedules, and default processes. Examine liquidity terms, including secondary markets, note transferability, and withdrawal options. Consider tax implications, noting that interest income is typically taxable, and platforms may issue 1099s or K-1s, depending on the structure. Align your investment allocation with your risk tolerance by matching it to your time horizon and financial goals.
The Bottom Line
P2P lending can suit fixed-income clients seeking higher income with tolerance for credit and liquidity risk. It is commonly recommended as a modest portion of a diversified portfolio rather than a core holding. As with any investment, clients should perform due diligence, start small, and scale thoughtfully.
