‘How safe is P2P lending?’ may well be one of the first questions that goes through your mind if you are considering P2P as an option for your money. Attractive returns may have initially turned your head, but worries over just how safe your money is will be a decisive factor.
The short answer to ‘How safe is P2P lending’ is that, like most savings or investment strategies, there will always be a degree of risk so it is impossible for your money to be 100% safe. What is possible however, is to manage your money in a way that limits your exposure to risk - you simply need to understand, be comfortable with, and know how to deal with any risks your money is subject to.
So, what are the risks of P2P lending?
The first thing to help mitigate risk is to understand them. We’ve outlined three key risks you should be aware of:
- Your money is not protected by the FSCS. Any money you ‘invest’ in peer-to-peer lending will not be covered by the Financial Services Compensation Scheme. This means that unlike traditional banks or building societies, if the lending platform collapsed, you are not eligible to receive FSCS compensation.
- Your money is at risk: As with all investments, it is important to understand that your capital is at risk as it may be subject to loan losses and defaults.
- Your money does not receive interest whilst waiting to be lent. It is in the interest of direct lending platforms to deploy your money quickly, but it can take time. Your money will not earn interest during this waiting period.
How to manage P2P lending risks
Select your platform(s) carefully. With over 80+ direct lending platforms in the UK, it is important that you choose your lending platform(s) with caution. There are a diverse range of lending practices and standards out there. We would suggest you check out the following when selecting a platform:
- How much solid credit experience does the platform have behind it? An experienced team will be able to originate and sensibly manage loans, as well as identify loans to steer clear of.
- How transparent is the lending platform? For example, how much information is accessible on their website detailing their record as a lender? Do they publish their default rate? What are other users saying, for example, do they have an independent customer review platform in place such as TrustPilot or Feefo?
Borrower selection. It is important to understand:
- the type of loan you are investing in (for example property, consumer or corporate). Is the loan asset backed? For example, has the borrower secured the loan against a property or business? This will mean you have more of a chance get some (or all) of your money back should the loan go bad.
- Who are you lending to? Are you lending to an individual consumer or a business? Have a balance of ‘borrower types’ and try to identify loans that could go bad (this isn’t always going to be possible) but if you can try to limit your exposure to unsecured lending and ‘bad apples’ it will help protect your return.
Spread your risk – diversify. Diversification is one of the key ways to minimise the impact of any losses. Although this can be time consuming, spreading your money across a minimum of 50 loans (100+ loans is ideal) will help you mitigate your exposure to risk. For example, if you invested £5,000 across 100 loans and one of the loans defaulted, your potential loss is £50. Conversely, if your £5,000 was spread against just 20 loans then your potential loss would be nearer £250.
Only invest a sensible proportion of your investment allowance. Most experienced P2P lenders invest no more than 25%-30% of their investment allowance in Peer-to-Peer Lending.
Be realistic. Generally speaking, the higher the rate of return, the higher the level of risk. A good rule of thumb is that if a return rate looks too good to be true, then it probably is.
If you spend a little time understanding and learning how to best manage any peer-to-peer lending risks, you will find that P2P lending could be a great option for your money – offering attractive returns with less volatility than investing in stocks and shares.
*Warning: nothing in this article should be construed as advice. Your capital is at risk
Free Peer-to-Peer Lending Guide
This article provides a brief overview of P2P lending risks. However, if you would like to find out about P2P lending in a bit more detail then our FREE P2P Lending Guide offers a comprehensive, informed, and impartial guide to everything you need to know about getting started with direct lending.