Alternative assets are a type of investment beyond the traditional stocks, bonds, mutual funds and cash. They can include investing in things like racehorses, art, collectibles, commercial real estate, or private equity. They are gaining in popularity as investors are nervous about a stock market correction, rising interest wreaking havoc on their bonds or they are tired on rates hovering around 1% on their savings accounts and CD’s.
Peer-to-peer lending (P2P) is one example of alternative investing that made a big leap in popularity in 2013. It is the practice of lending money to unrelated individuals without going through a traditional financial intermediary such as a bank or a financial institution. This lending takes place online on peer-to-peer lending companies’ websites using various different lending platforms and credit checking tools matching individual borrowers or companies with savers willing to put money aside for longer, hunting for a good return.
As the banking middle-man is cut out, borrowers often get slightly lower rates, while savers get far improved headline rates, with the sites themselves profiting via a fee. While it can work well if you’re able and willing to lock cash away, it’s important you understand the risks of this hybrid form of saving and investing before parting with your cash.
Lending platforms like Lending Club and Prosper have quickly become popular and reliable ways of doing P2P lending. These websites simplify the process and do a lot of the work for you, like bookkeeping and transferring the funds in question, without charging as much as banks. After signing up with the website, borrowers essentially just select a loan amount and describe where this money is going before posting a listing to the website.
Investors, meanwhile, sort through these listings and invest in whatever they think will fetch the biggest returns while minimizing their risk that the borrower will default. Borrowers make monthly payments, which investors receive a portion of. Because loans are uninsured, default can be especially painful for investors. For some, this risk is worth it, as returns can be substantial.
Online platforms such as Lending Club and Prosper Marketplace match lenders with borrowers of varying credit risks, offering net annualized returns of around 8 to 20 percent. Investors usually take fractional shares of large numbers of notes to mitigate risk of defaults. Both platforms provide profiles of the creditworthiness of the borrowers and the performance characteristics over time of the notes they issue. The platforms then offer the notes in what is essentially an auction. Once a note attracts a sufficient number of investors, the loan is originated and serviced. Platforms charge borrowers a one-time fee and lenders a monthly service fee.
Background checks serve as a security blanket: websites like Lending Club and Prosper perform background checks on borrowers, which eliminate a lot of the mystery associated with lending money to someone you’ve never met before. You’ll know the credit score of whomever you are lending money to, along with other pertinent facts about their financial background.
The main risk involved in peer-to-peer lending is borrower default. In order to ensure borrowers can be trusted to repay their loans, a stringent process of underwriting is carried out for every application. This includes a full credit check, an affordability assessment and a thorough identity check. Every borrower must also submit to an anti-fraud background check against the CIFAS register.
While for many, it’s worked well, returns and indeed your capital are not guaranteed and the primary risk is, of course, not being repaid. Each peer-to-peer site has its own way to mitigate this risk – most work well, but it is still important to do your due diligence and consult with your advisor before jumping in.