No doubt peer to peer lending proves to be an excellent alternative investment for those looking for high returns. But like all other financial products, it has some risks. If you are thinking of investing your money in p2p loans, you must be aware of the risks so that you can take proper measures to mitigate these risks. The risks that cause monetary losses in p2p lending are categorized into three main categories by experts. In this article, we are describing these risks in detail and some effective ways to minimize them. In general, it is essential to educate yourself before you invest in any risky asset.
Now let’s take a look at the major risks associated with p2p lending.
It is the most common risk and a significant reason for losing money in p2p investment. When your borrowers are not able to repay the loan amount, this risk is known as credit risk. It is the most time evaluating the risk of all the risks of peer-to-peer loans. When a loan goes bad, lenders expect that other good loans would be enough to cover this loss. There are some p2p platforms that offer contingency funds to cover the lenders in case of borrower default. There is some additional coverage, such as the property loans are secured loans so that the loan amount can get back by selling the collateral.
However, be mindful that if a number of borrowers default simultaneously, then the contingency fund can not help you, and you will lose all your money. This risk can vary greatly from one platform to the other.
If you want to minimize this type of risk, you must invest your money with a p2p platform that has quality borrowers or offers loans secured against prime collaterals. You should look at the statistics of the platform to know the ratio of bad debts. It will help you in choosing the right platform and lower the risk of default.
Before investing money in p2p loans, the first question that comes to mind is how risky a peer to peer lending is? The answer to which depends on you more than anything else. It depends on how much you calm down, step back and look at the facts when you are making credit decisions. The most significant risk while investing in p2p loans is what happens inside your head. Instead of getting cautious, we become greedy and get scared when we should be greedy. It is called psychological risk, and investors who rub their hands with greed over money are more likely to earn high returns. However, most people who want to make high returns put themselves in worse situations than those who use intelligent investment options in p2p lending and reinvest to enjoy the benefits. Investing in p2p lending is quite straightforward when you study and understand it. It is pride, fear, and greed that get you down.
From all the p2p risks, it is easier to avoid the psychological risk. The best way is to avoid all the experts, crowd, and what p2p lending websites are saying about the interest rate. You must set your investment goals that can be easy to follow and help you in finding the right platform and loans to invest your money. For example, when you invest in real estate, you can set a criterion that you will lend money to only experienced borrowers to avoid the risk of losing money.
If you invest all your money in a single loan, no matter how experienced and well-reputed your p2p website is, you can have bad luck and lose all your money. This type of risk is known as concentration risk. We can also say that this type of risk occurs due to insufficient diversification.
You can reduce this type of risk by spreading your investment across multiple loans of different risk categories. P2p platforms allow you to choose borrowers, so you should access the borrower’s profiles to find the risk level. Always keep in mind that the more the interest rate, the more will be a risk. So you should look beyond the interest rate and invest according to your risk tolerance. When you invest your money in different loans, the chances of losing money are reduced because you can continue earning profit even if one borrower defaults.
Other than these three main risks, there are some additional risks, such as you can lose your money if the collateral does not sell at the expected value, and sometimes the p2p platform goes bust or goes out of business.
By keeping all these risks on your mind when investing in peer-to-peer lending, you can be cautious and invest in a way to reduce these risks. You must do research, study p2p lending and understand it so that you can invest your money in an efficient manner without taking many risks.