What You Should Know About Peer-To-Peer Loans
Peer-to-peer loans are a form of lending where individuals and businesses borrow from each other without traditional financial institutions. Lending mostly happens online via peer-to-peer platforms. These services are marketplaces that connect investors, lenders, and borrowers.
Peer-to-peer loans offer investors better returns than savings accounts and give borrowers a faster route to credit than traditional banks. However, they are not cheap, because borrower risk is hard to assess precisely. The higher risk translates into higher interest rates.
Investors should understand in detail where and on what terms they lend their money to stay aware of investment risks and ethical considerations. In addition to investing in peer-to-peer loans, it makes sense to diversify into other assets such as stocks
Parties Involved
Peer-to-peer investing involves several parties. Typically, an investor opens an account with a suitable peer-to-peer platform that connects investors with lending companies.
Lenders seek funding on marketplaces for loans to their customers—businesses and individuals. Investors rarely lend directly to end borrowers; instead, they lend to the lender, who signs loan agreements with borrowers. The investor’s role is to finance the lenders’ operations. In return, they receive interest and principal as borrowers repay. Investors can usually choose which types of loans to fund and through which lenders.
The borrower receives the loan from the lender, who has funded the individual loan with investments from multiple investors. Consequently, investors have no practical role in the loan transaction itself—they only provide funding. Lenders charge borrowers various fees and commissions to fund their operations. Investors are rarely charged service fees on peer-to-peer platforms.
Roles and responsibilities can vary across platforms, so review them carefully before investing.
Sometimes the borrower and the investor use different currencies. In that case, the lending company or the peer-to-peer platform trades currencies with a third party. It’s important to understand who bears the exchange-rate risk: the investor, the platform, or the lender. If the lender takes the risk, check whether it is hedged. A sharp currency drop can cause severe financial stress for the lender, putting investor capital at risk.
Diversification
Peer-to-peer platforms encourage spreading your investment across hundreds of different loans. Diversify loan sources to ensure loans come from different lenders. Invest no more than 50 euros per loan to keep overall risk low. You can further reduce risk by mixing loan types—business and consumer—and by ensuring loans are spread across different regions and, where applicable, currencies. Understand the currency risks associated with foreign currencies.
On many platforms, investors can pick individual loans or let automation select loans based on chosen criteria. The automation searches for loans matching the desired interest rate, reliability, or term.
Expected Returns
Peer-to-peer investments typically yield about 5 - 20per centt per year. You should subtract expected losses from the headline rate. In the best case, there are no losses, but depending on the platform and lender terms and borrowers’ ability to pay, credit losses can materialise. With diversification, expected losses usually remain below expected interest.
Based on our experience, careful selection delivered net returns of 5 - 10 per cent. Investing carries risks, and unexpected events can materially reduce expected returns. Russia’s invasion of Ukraine was an unfortunate example. You can lose money with peer-to-peer lending, and even the principal is not guaranteed.
Peer-To-Peer­Investing Risks
We list the risks related to peer-to-peer loans and explain how to reduce them.
Marketplace Reliability
Peer-to-peer loans are usually traded on third-party marketplaces. Some are licensed, while others operate without oversight. Marketplaces almost always highlight their trustworthiness, but until an independent party has assessed it, the marketplace poses a significant risk. The platform’s own funds and client assets must be kept separate. That’s not always the case. Choose platforms carefully, and trade only on peer-to-peer platforms with a sufficiently long track record. You can gauge reputation, for example, by Googling reviews.
Lender Reliability
Lending companies seek funding on peer-to-peer platforms. They use that funding to grant loans to their customers. The solvency and reliability of these companies vary. It’s possible the lender cannot pass principal or interest back to the investor even if the borrower pays. The lending company may become insolvent or otherwise refuse to meet its obligations. Therefore, it is useful to diversify peer-to-peer investments by spreading them across loans from multiple lenders. Lend only through well-capitalised, reputable lending companies.
Borrower Ability To Repay
Ultimately, the borrower repays interest and principal to the lender, and payments eventually reach the investor. If the borrower defaults, the investor usually does not recover their money. Lenders send unpaid loans to collections, but it’s common not to recover all principal and interest. In that case, the investor loses part of their investment.
Certain lenders offer a buyback guarantee (in English, Buyback Guarantee). In this case, the lender promises to repurchase loans from the investor at full price plus interest if the borrower fails to meet obligations for 60 days. In other words, the lender promises to take the loss. In theory, this removes borrower default risk for the investor, but the lender may still fail to honour the buyback.
Scams
Not all peer-to-peer platforms are trustworthy; some may exist only to collect money. Do not invest through new platforms until their operations have proven legitimate.
Taxation Of Peer-To-Peer Returns
Returns on peer-to-peer investments are generally subject to capital income tax, which in Finland is at least 30 per cent. Platforms may withhold tax at source, but not always. Foreign marketplaces usually withhold tax in the country where the company is registered. In that case, the tax paid to that country must be reported to the Finnish Tax Administration, along with the interest income, and the foreign withholding tax is credited in Finnish taxation. Investors can also reclaim withholding tax paid abroad if it exceeds the limits set by the tax treaty.
Guide To Getting Started With Stock Investing
Well-Known Peer-To-Peer­Platforms
Mintos
Mintos is a licensed peer-to-peer marketplace from Latvia. The license was granted by the Central Bank of Latvia.
Through Mintos, you can invest in loans from numerous lenders in different countries. You can choose loans yourself or let Mintos automate selections based on your instructions. Mintos also offers ready-made portfolios for diversification. Funds can be allocated to various loan types aimed at consumers and businesses. Mintos’s web service and mobile app are easy to use, and transfers work quickly in both directions. Mintos’s product portfolio has been expanding continuously, and the service is no longer limited solely to peer-to-peer loans.
Mintos has its own secondary market for buying and selling the peer-to-peer loans it intermediates. When problems arise, Mintos handles recoveries from lenders and reports progress regularly.
We had years of experience with Mintos and considered it reliable. Not all Mintos lenders, however, were trustworthy, resulting in minor credit losses for us. Among those proving unreliable were Russian and Turkish lenders. Overall, Mintos felt like a decent peer-to-peer platform that offered reasonable returns. Thorough diversification was essential!
Loans on Mintos come with lenders’ buyback guarantees. It’s up to the investor to decide whether to trust these promises.
Viainvest
Viainvest is a licensed peer-to-peer marketplace from Latvia. The license was granted by the Central Bank of Latvia.
Viainvest is similar to Mintos but offers a more limited selection of loans. On Viainvest, you can also manually select loans or let automation select them based on your preferences. There is no secondary market. Investors can allocate funds to both consumer and business loans worldwide.
Loans on Viainvest generally include a buyback guarantee. It’s up to the investor to decide whether to trust these promises.
Lendermarket
Lendermarket is an unlicensed peer-to-peer platform from Ireland.
Lendermarket promises higher returns than Mintos or Viainvest. You can choose loans yourself or let automation invest funds according to your instructions. Recently, withdrawals and returns from Lendermarket to a bank account have been slow because its largest lender, Creditstar, has failed to remit loan principal and interest on schedule. Lendermarket offers higher expected returns than Mintos and Viainvest, but the risk level is clearly elevated. We recommend using only licensed marketplaces and therefore skipping Lendermarket.
Loans on Lendermarket generally include a buyback guarantee. It’s up to the investor to decide whether to trust these promises.
Fellow Finance
Fellow Finance was a Finnish peer-to-peer marketplace. Today, the company is known as Alisa Bank, and you can no longer invest in new peer-to-peer loans through it. Alisa Bank focuses on traditional banking services such as offering a credit card.
What To Know Before You Invest
Before investing in peer-to-peer loans, you should at least understand the following.
- Investing involves risks, and you can lose both returns and principal.
- When choosing peer-to-peer loans, find out who receives the loans. Avoid short-term, high-interest consumer loans, as they may push borrowers into financial trouble.
- Business loans and secured peer-to-peer loans are often more sustainable options, although returns may be lower.
- Loans used for business invoice financing are also a good option if receivables are used as collateral.
- Research experiences with any new marketplace before you start trading. Make sure the marketplace is licensed to operate.
- You must pay tax on returns. Often, you need to report the income yourself.
Questions and Answers
- What is peer-to-peer investing?
- In peer-to-peer investing, investors and borrowers meet without the involvement of traditional financial institutions. Trading usually takes place on peer-to-peer platforms.
- Are P2P investments risk-free?
- Definitely not. The marketplace, lenders, and borrowers all involve significant risks. Fraud can also occur.
- How much return can you get from P2P investing?
- You can expect 5-20 per cent per year, but all investing carries risk. You might earn nothing and can even lose principal.
- How can you reduce P2P investing risks?
- Use only trusted platforms, invest via reputable lenders, and diversify so your funds span hundreds of different borrowers.
- Do you have to pay tax on P2P returns?
- Yes. You must pay at least 30% tax.
- Can you withdraw funds from P2P loans at any time?
- No. Some platforms offer a working secondary market where you can sell loans and withdraw funds before maturity.
- Which P2P platforms exist?
- Among others, the Latvian platforms Mintos and Viainvest and the Irish platform Lendermarket are well-known marketplaces.
Bottom Line
Peer-to-peer investing is a viable alternative to savings accounts, stocks, and funds. Compared with savings accounts, the risk level is much higher. You can expect returns of roughly 10-15%, but credit losses are common. Actual returns are therefore lower.
To manage risk, choose peer-to-peer platforms carefully and spread funds across numerous different loans. It’s sensible to invest in different loan types across countries to achieve broad diversification. With broad and diversified exposure, the impact of individual credit losses remains small.