Peer-to-peer (P2P) lending is a kind of direct lending to individuals or businesses with no official financial institution participating. Generally, the transaction is completed through online platforms that make lenders meet potential borrowers.
The P2P lending model is based on the crowd-funding model. It provides flexibility, convenience, and the choice of borrowing and lending. Many P2P lending platforms are organized as Non-Banking Financial Companies (NBFC).
A borrower can avail of both secured and unsecured loans via P2P lending. But most of the loans are unsecured personal loans. This industry does not usually see secured loans and is backed by luxury goods.
Many individuals view peer-to-peer lending as an alternative source of earning. Bonds, stocks, mutual funds, gold, and other market-linked products witness daily fluctuations. But P2P lending does not have any such market-related risks. The value of your investments in P2P lending does not fluctuate regularly.
The peer-to-peer lending model: How does it work?
P2P lending is a direct process. A specialized online platform facilitates the exchange of funds. The different steps undertaken between the borrower and the lender during the P2P lending process are as follows:
- When a borrower needs money, they fill out an online application form on the P2P lending platform.
- The risk and credit rating of the borrower is evaluated by the platform with the help of the information provided on the application form. Based on the results, an appropriate interest rate is assigned to the applicant.
- If the platform approves the application, the applicant is sent details of the available options from the investors.
- The applicant evaluates the potential borrowers before choosing one.
- The applicant must pay interest payments periodically and repay the principal amount at maturity.
The P2P lending platform earns a commission from the lenders and borrowers for the service provided.
P2P lending returns
Similar to other investment opportunities, P2P lending returns depend on your risk appetite. There are two parameters to measure the risk:
- The borrower’s credit rating
- The loan tenure
If the lending period is long, the returns will be higher. If the borrower has a poor credit track record, the returns will be higher.
P2P lending vs. mutual funds: Which is better?
P2P is a cash-flow investment. You earn monthly returns and help people who need money. However, it is not a great idea to only focus on the returns while investing. An investor must maintain diversity by investing in several asset classes to enjoy long-term benefits.
Adding the instrument to your investment portfolio can help increase your portfolio returns. By diversifying 10 to 15 percent of your investment in P2P lending, you can expect an increase of 1 to 1.5 percent in your overall returns.
Conclusion
A portfolio with fixed deposits, equity, and mutual funds SIP can generate an average return of 15 percent. With investment in P2P lending, you can add more value to your diversified investment portfolio. Unlike equity, P2P lending is not volatile. It protects the principal amount, but there can be a deterioration in returns if the borrower defaults. Using the Tata Capital Moneyfy App for goal-based investment options, you can achieve the diversification you need in your portfolio.