I have been following the conversations about p2p lending on a few popular personal finance blogs in the last month or so. In the comments section I have noticed that many people claim to like the idea of investing in p2p lending but still haven’t taken the plunge.
Lazy Man and Money gave an update on his Lending Club investments that brought in several comments from prospective investors. Sam from Financial Samurai wrote this article on the Yakezie blog that also garnered many comments. Other recent blog posts that have prompted some discussion include Beating Broke, Sweating the Big Stuff and Bible Money Matters.
What is holding prospective investors back from opening an account with Lending Club or Prosper? The objections from potential investors on these blogs typically fall into one of these five categories.
1. Borrowers will just default on their loans
There is a sentiment out there that goes something like this: I wouldn’t lend my money to a stranger I just met on the street so how is it any different lending money to a stranger online? It is very different. First, these borrowers have to submit to credit checks and they have to confirm their identity in a variety of ways. Then investors have to deem the borrower a good credit risk and invest in their loan. Even with all these factors there are still defaults, that is true. But default rates are relatively low and can be mitigated somewhat by spreading your risk among a large number of loans.
2. The returns sound too good to be true
My father used to say, “if an investment sounds too good to be true, it probably is too good to be true.” In today’s investment environment people see returns of 10% and think there must be some catch, that no one can earn those kinds of returns without taking on substantial risk. Whether or not the risks of p2p lending are substantial is a subjective matter, but there certainly are risks. But with some best practices people can minimize their downside risks and quite possibly achieve double digit returns.
3. It is too time consuming
Many people hear about the need to diversify into many loans, possibly hundreds of loans, in order to protect their investment. They think they can’t possibly read and consider hundreds of loans and then keep track of them all once they are invested. I would agree with that statement. Even though I am invested in over 2,000 loans total, I can check on the status of all my existing loans as well as invest in new loans using the online tools in just a few minutes a week. Now, there was some work involved in getting to this point but the truth is you don’t have to spend a lot of time on your p2p investments unless you want to.
4. These companies aren’t making any money
This is a valid concern and one that has been discussed at length on this blog before. It is true that both Lending Club and Prosper are not profitable yet but they are growing fast and have plenty of cash on hand. Having said that, they may need further venture capital investments (this is highly likely in Prosper’s case) in order to stay in business so there is a risk that these companies may run out of cash. Now, I don’t believe that is likely – but it is a concern that potential investors need to take into consideration.
5. I am going to wait and see what happens
The wait and see approach is very common. I see many comments from people (and these are people who read personal finance blogs so they have at least a passing interest in investing) who say they keep hearing about p2p lending but they want to stay on the sidelines for now. That is fine – meanwhile these investors have to deal with stock market fluctuations and interest rates on CDs and money market accounts that are very close to zero. One day they may come back and revisit p2p lending.
I am sure there are other excuses so I would be interested to hear from readers on this one. What do you hear from your friends and family when you tell them about p2p lending? Please share in the comments.
