How Safe Is It To Invest Money In P2P Lending? What If A Borrower Defaults?
P2P lending or Peer to Peer lending is a new form of lending and borrowing money. It makes use of technology to connect the lenders and borrowers, thereby making loans available to a wider range of people.
If you are looking to invest your money, you can lend it to a borrower on the P2P platform and the interest accrued on the loan will be your reward. You can either invest in a single loan or spread your investment across multiple loans. You can even decide to contribute only a portion of the full amount required for the loan. The interest rates you can charge will depend on the borrower’s profile and credit history.
When a bank is approached for a loan, they perform a background check and look at the credit score of the borrower. Only those people with a good credit score are eligible for bank loans. With P2P loans, borrowers don’t have jump through these hoops, making the disbursal of the loans faster. These are some of the reasons why peer to peer loans have gained popularity.
Lending on P2P platforms is being touted as the best way to invest your savings. Investors can get 12 to 36 % returns per annum by lending on P2P platforms. The figure is, of course, very tempting. But is this valid? Can one really get such high returns? Aren’t there any inherent risks?
How Safe is P2P Lending?
One of the questions that pop up in the head of anyone who wants to invest in a P2P platform is safety. There are no straightforward answers to this question. If you choose to lend to only credible borrowers, your investment will be safe. Here are a few things to look out for.
Once you create a lender account on a platform and register successfully, you will be shown a list of borrowers. Start by checking the basic information of the borrower such as their credit score, the purpose of the loan, tenure, and history of loan repayment. This will give you a clear picture of the trustworthiness of the borrower. But there is a catch here. You can charge a higher interest rate from those borrowers with a low credit score. You may not be able to get the same from interest from a low-risk borrower with a good credit score. You need to understand that the high rate of interest also comes with higher default risk.
The best way to generate alpha in your portfolio is to diversify your investments. Invest at least half of your money in medium risk loans. Then invest at least 30% in low-risk loans. You can invest the rest in high-risk loans. Or you could just invest in medium and low-risk loans. This way, you are putting the least amount of money at risk and you still get a good rate of interest. The trick is to find the right balance between risk and reward. Playing it too safe will not generate good returns. At the same time, putting all your money into one basket increases your chance of losing all your capital.
Don’t throw yourself into the deep end of the pool in the beginning. You can start by investing a small amount. Look at your finances and figure out an amount with which you can experiment. You should invest this amount on the platform. Once you have learned how to choose the borrowers, how to diversify the money and you start seeing returns, you can increase your investment.
Even though P2P lending started out in India in 2014 as an unregulated space, RBI issued guidelines to be followed by these platforms and allowed them to be registered as Non-Banking Financial Companies or NBFCs on September 2017. Before investing on a platform, check if the platform has registered with the RBI and has been compliant with the regulations.
Following the above few tips will ensure that your money is safe and you continue to enjoy the benefits of the high returns.
What if a Borrower Defaults?
You have invested safely and done everything you can. But the worstcase scenario happens and the borrower defaults. What happens now? To start with, you need to understand that even though P2P platforms are less stringent than banks in giving loans, they are not negligent about background checks. The platforms are aware that there is a real risk of borrower default and have safeguards in place for such a situation.
Auto-debits are used to withdraw the EMI from the borrower’s account. This is followed up with reminder calls and messages. If the borrower refuses to pay, the security cheque is used to cover the repayment. This will be followed up with legal action. The platform will also have a collection agency that can take over the recovery process of the loan. The lender will be updated about all the steps taken for loan recovery. To top this, RBI requires the NBFCs to update credit agencies about the loan repayments. So, a default on a registered platform will negatively affect the borrower’s credit score as well. Considering all the safeguards in place, a default will be a rare occurrence. This makes peer to peer lending a very safe method of investing money to get good returns. A little consideration and research while choosing the P2P platform and borrower are all it takes to make your investment safe.