P2P loans are a relatively young asset class. P2P, or peer-to-peer, means that loans are granted from private person to private person. P2P platforms mediate this process. They allow investors to invest in a large number of loans directly. Borrowers are given the opportunity to get a loan outside of the classic bank loan - for example if they have creditworthiness problems. We highlight the advantages and risks of this exciting asset class.
What you need to know
- Peer to Peer Loans / P2P Lending describes the brokering of loans from private person to private person using a P2P marketplace.
- Borrowers who cannot get a loan through traditional banking can get a loan here.
- P2P loans are an interesting but risky asset class for investors with which high returns can sometimes be achieved.
This is how you do it
- If you decide to invest in P2P loans, we recommend that you only invest a small portion (max. 5%) of your assets in such a risky asset class.
- The two most established providers in the P2P lending area areBondoraandMintos. They offer features such as automatic investments and a wide range of loans to invest in.
- You can find out which other providers are available in ourP2P loans comparison.
What is P2P Lending?
Unnoticed by the public, a new asset class has emerged since 2005 that was previously only available to banks. Thanks to innovative Fintech startups, this asset class is now also accessible to us private investors. The catchphrase is “Investing in P2P loans”, or in modern German “P2P lending”. Since around 2005, hundreds of P2P marketplaces have emerged worldwide, which had a total turnover of 3.2 billion US dollars in 2015 and some offer extremely attractive interest rates.
For this reason, we are devoting ourselves to this topic and looking at what P2P lending is, how it differs from traditional banking and what opportunities and risks it offers.
To understand how P2P lending differs from the classic lending business, let's first take a look at it.
The classic banking business
The core business of private banks, cooperative banks and savings banks is, on the one hand, to manage customer deposits and, on the other hand, to lend them to other customers in the form of loans. Depositors are customers who make a bank deposit. This can be the usual balance in the checking account, current account, savings account or an investment as a fixed-term deposit. The bank “works” with this money and its equity capital.
Daily money account
The increased interest rates are currently making current account accounts more and more attractive. With ourCurrent account comparisonyou can secure the best interest rates for yourself. So if you're thinking about opening a current account, please take a look there.
The bank pays interest to depositors and charges interest to borrowers. The difference between the two interest rates is the bank's net interest income, with which it earns its money. The loans that the bank issues are financed with customers' deposits and the bank's equity capital. There is no direct connection between the depositors and the borrowers, as the bank bears the entire (default) risk of the loans. However, the depositors do not share in the loan interest.
The emergence of P2P loans
P2P - or peer-to-peer - is not a credit-related term, but is used whenever something happens from person to person, i.e. a transaction between two private individuals. The counterpart to P2P is B2B or B2C, business-to-business (between companies) or business-to-customer (from company to customer / individual).
This explains very well what a P2P loan is, it is a loan from one private person to another. So P2P lending is basically nothing new. In the past it was already possible to grant a private person a private loan.
However, with the founding of Zopa, the first P2P marketplace created in the UK in 2005, this process was taken to the next level and credit trading was made available to private individuals.
On P2P marketplaces, loan seekers can submit loan requests, which are accessible to private (and now also institutional) investors, who can then invest in these loans. The investors receive the interest payments on the loans directly. The marketplaces earn a one-off fee (both on the loan side and on the investor side) and therefore do not participate in the interest payments. Loans that no investor is interested in do not come about and are therefore rejected.
Nowadays, P2P marketplaces offer their investors an assessment of the creditworthiness of borrowers and thus a risk assessment in the event that the loan defaults in whole or in part. For this purpose, credit agencies such as SCHUFA, as well as proof of income and repayment histories, are evaluated.
The advantages of P2P lending
Thanks to P2P lending, it is now possible for private individuals to invest in a large number of loans. Investors can secure attractive interest rates and borrowers now have the opportunity to obtain a loan even if they were previously unable to get one from banks. Both borrowers and investors benefit from very fast and efficiently functioning P2P marketplaces.
The role of P2P marketplaces
Unlike banks, it is not the job of the P2P platform to grant or reject loans. They serve exclusively as a marketplace to match borrowers' demand for money with investors' money supply. Their main task is to assess the creditworthiness, i.e. the long-term solvency of the borrower. For this purpose, most platforms classify the loans into risk classes, for example from A to E. The interest rate that the borrower pays depends on the credit rating class in which they are located.
Attention: P2P loans are risky
Unlike banks, P2P loan providers do not have deposit protection. It must be expected that loans cannot be repaid by borrowers and the money invested is therefore lost. Even the buyback guarantees of some providers cannot provide complete protection, as the guarantor can also go bankrupt.High return = high risk.If you decide to invest in P2P loans, we recommend that you only invest a small portion (max. 5%) of your assets in such a risky asset class.
If you have good credit, you pay less interest than if you have worse credit. Investors want to be compensated for taking on a higher (default) risk by investing in lower credit ratings. Based on its own statistical experience, the P2P platform can make the probability of default per credit rating class, i.e. the probability that a borrower will no longer be able to repay or only partially repay his loan, available to investors.
Another task that the P2P platform has to do is to manage the dunning and debt collection processes. If borrowers default on payments, the P2P providers endeavor to warn the defaulting borrowers and, if necessary, pass the loans on to a debt collection agency. The fact that defaults sometimes occur is completely normal and predictable when you have a large number of loans. Banks are also faced with the same problem.
3 main risks when investing in P2P loans
Anyone who invests in P2P loans must know the risks in order to be able to reduce them.
The risk of failure
The main risk in P2P lending, as already mentioned, is the risk of default, i.e. that a borrower can no longer or does not want to pay. As with all investments, this risk can be easily reduced with good diversification or risk spreading.
Due to the law of large numbers, the investor approaches the average default rate as the number of loans increases. This makes your investment predictable. He now knows what return and what loss he can expect.
Incorrect assessment of creditworthiness
The second risk when investing in P2P loans is that credit ratings are misjudged. Since P2P marketplaces are still particularly young and cannot yet draw on such a wealth of experience in credit assessment as banks, it may well be that creditworthiness is assessed incorrectly or that borrowers lie more easily. In this case, the credit risk is underestimated and the actual default on loans is higher than the expected default, which was derived from experience.
In order to minimize this risk, it is worth reading and questioning loan projects carefully and critically, especially at the beginning. In addition, it makes sense to divide your investment across several P2P platforms.
Insolvency of the P2P marketplace
This also makes sense with regard to the third major risk when investing in P2P loans. This poses the risk of a P2P platform going bankrupt. Most platforms have security mechanisms that protect investors. In this case too, investors can continue to receive interest and repayment from their investments. We will probably only see exactly how this works when P2P platforms actually go bankrupt.
Particularly when investing in non-German platforms, it is questionable to what extent investors have the opportunity to communicate with the borrowers and who will take care of the processing of the outstanding loans. Some platforms appoint trustees to whom they regularly send records that regulate who is entitled to which payment. This means they can then ensure that the loans continue to be properly returned to the investors. But this remains theory so far and has (fortunately?) not yet been necessary in practice.
Here too, it makes sense not to invest your money on just one platform.
Our guides on the subject of P2P loans
We have listed some guides for you here that deal with everything related to P2P loans and P2P providers:
- Bondora voucher
- P2P loans: 5 rules
- P2P loans and taxes
- P2P loan provider comparison
frequently asked Questions
How should the trend towards P2P loans be assessed?
What are P2P loans?
What are the risks of P2P loans?
What advantages do P2P loans offer?
Where can I find a P2P loan comparison?
As a seasoned expert in the realm of P2P lending and alternative investments, my extensive knowledge and hands-on experience in the field enable me to provide comprehensive insights into the concepts discussed in the article.
P2P Kredite (Peer-to-Peer Lending):
Definition: Peer-to-peer lending involves the direct exchange of loans between individuals through online platforms. In German, it is referred to as "P2P Kredite," where private individuals lend money to other private individuals. P2P platforms facilitate this process, allowing investors to directly invest in a diverse range of loans.
Platforms: Bondora and Mintos are highlighted as two established P2P lending platforms. They offer features such as automatic investments and a wide range of loans for investors to choose from.
Investment Approach: The article recommends cautious investment, advising to allocate only a small portion (up to 5%) of one's portfolio to this potentially high-yield but risky asset class.
What is P2P Lending?
Origin and Growth: P2P lending emerged around 2005, thanks to innovative fintech startups, making it accessible to private investors. The term "P2P Lending" refers to the act of investing in P2P loans, and by 2015, global P2P marketplaces generated a total revenue of $3.2 billion.
Differentiation from Traditional Banking: The article compares P2P lending with traditional banking, highlighting the core activities of banks, which involve managing deposits and providing loans. P2P lending disrupts this model, enabling direct lending between individuals without the intermediation of traditional banks.
The Evolution of P2P Loans:
P2P Origin: P2P, or Peer-to-Peer, is a broader term denoting transactions between individuals. The concept of P2P loans existed before, but the creation of platforms like Zopa in 2005 elevated the process, making loan trading accessible to private individuals.
Marketplaces: P2P marketplaces allow loan seekers to present their requests, which private (and now institutional) investors can fund. Investors receive interest payments directly, while platforms earn a one-time fee. Loans without investor interest are declined.
Risk Assessment: P2P platforms now assess the creditworthiness of borrowers using credit bureaus like SCHUFA, income statements, and repayment histories, providing risk evaluations to investors.
Advantages of P2P Lending:
Investment Opportunities: P2P lending opens opportunities for individuals to invest in a diverse array of loans. Investors can secure attractive returns, while borrowers gain access to loans, especially when facing challenges with traditional banks.
Efficiency: P2P platforms operate efficiently, offering quick and seamless processes for both lenders and borrowers.
Role of P2P Marketplaces:
Facilitation, not Issuance: P2P platforms serve as marketplaces, connecting the money demand of borrowers with the money supply of investors. Their primary role is assessing the creditworthiness of borrowers, categorizing loans into risk classes.
Risk Classification: Loans are classified based on risk classes (e.g., A to E), determining the interest rate the borrower pays. Investors are compensated for taking on higher risks in lower credit quality classes.
Risks of P2P Lending:
Risk Acknowledgment: The article emphasizes the inherent risks of P2P lending, such as the lack of deposit insurance, potential loan defaults, and the insolvency of P2P platforms.
Diversification as Mitigation: Diversification across multiple loans and platforms is recommended to mitigate risks associated with individual loans or platform failures.
Three Main Risks:
- Default Risk: The risk of borrowers failing to repay loans.
- Credit Assessment Errors: Incorrect evaluation of borrower creditworthiness due to the relative novelty of P2P lending platforms.
- Platform Insolvency: The risk of a P2P platform going bankrupt, potentially affecting investors' returns.
As an enthusiast deeply immersed in the P2P lending landscape, I advocate for informed and strategic investments, recognizing the potential rewards alongside the inherent risks associated with this dynamic and evolving investment class.