How much money can I actually make with peer to peer lending?
Although peer to peer (p2p) lending can be considered a ‘fixed-interest’ class of investment, it isn’t easy to know how much return it actually provides. That’s because there are a number of ways it can be setup and the % rate for a p2p investment doesn’t equate to the % rate for a savings account (or similar). It’s important to consider the following figures when you make your calculations:
- The amount of money you want to invest (capital).
- The number of years you want to invest.
- The p2p rate (%).
- The savings account rate you have access to (%).
To quickly calculate, check out this calculator: theinvestmentcalculator.com. For more detail on how this works, read below.
How does peer to peer lending work?
To invest in peer to peer lending, you give some of your cash to a person/organisation in one lump sum. They then repay you the loan plus interest in monthly instalments in much the same way as a car/home loan. Except in this case you’re the lender. For example: If you want to invest $1000 for 5 years at p2p rate 9%, then for every month over the next 5 years you will receive $20. The $20 will include both interest and principal (capital) components. What you then do with this $20 each month is your choice, which could be one of:
- Do nothing (often the default – but not advised).
- Invest elsewhere – like a savings account.
- Invest in more p2p loans.
There are trade-offs between options 2 and 3. With 2, you eventually have cash available (liquidity) after the loan period for other types of investment (or spending) but your returns are a bit lower. With 3, you don’t have an easy way to use the cash you’ve invested (low liquidity) however the returns are a bit higher.
How much better is it than a term-deposit or savings account?
The savings account rates in most countries are lower than the p2p rates. So why would anyone bother getting a savings account if they could just use p2p? The answer is liquidity; you have full access to your money whenever you need it no questions asked. It’s important not to underestimate this benefit – investing for growth is important, but it’s equally as important to make sure you have enough cash when you need it. As a rule of thumb, keep at least 3-6 months of your net income in cash – more if you predict heavy expenses in the future.
So what to do? The answer is it depends. What are your numbers (as above), and what are your investment goals? Are you: saving for near term expenses, saving for a rainy day, looking for long term growth without the need to spend in the short term? It’s best to calculate before making the decision to invest.
What else do I need to consider?
With all investments, there are some risks and terms & conditions. It’s important to know these ahead of time and ask the provider any questions you might have. There are strategies p2p providers use to mitigate the risk that your loan will not be repaid, however in the worst case scenario (e.g. financial crisis) this could happen. Or, for other reasons you may want to get out of your p2p loan – which could be difficult, or possible but attract fees.
In any case, if you were to have the loan exit before the end of the period, the earlier this happens, the more money you would lose. After a certain point in time however, much of the loan is already repaid (along with some interest) at which point you would not have lost any money. This period of time is called – the payback period. For the example above: this is 3.92 years; before this time if the loan defaults you will lose some money, afterwards you will not. See here for further detail on p2p.
Although p2p can be considered ‘fixed-asset’, it is difficult to calculate. It is also important to understand your financial goals during this process along with the risks involved. There are different ways p2p loans can be structured to meet these needs. To find out for your particular situations start here: theinvestmentcalculator.com.