Crowdlending, also known as peer-to-peer lending (abbreviated as P2P lending) is the practice of lending money to individuals or businesses through online platforms that directly match lenders with borrowers, bypassing banks and other financial institutions.
Crowdlending companies usually operate online, so they can run with lower overhead and provide the service more cheaply than traditional financial institutions:
- Borrowers can borrow money at lower interest rates.
- Investors (that is, lenders) receive a higher return compared to savings in term deposits or investments products offered by banks.
- P2p lending companies take a benefit for providing the loan market platform, connecting borrowers with lenders, and credit checking the borrower.
History of Crowdlending
Crowdlending is a relatively new concept. Many specialists consider the launch of Zopa in the UK in 2005 as the origin of the crowdlending business model, followed by LendingClub and Prosper in the United States in 2006.
After the financial crisis, many banks became reluctant or, at least, much more restrictive to give loans, especially in certain countries. This left a lot of people without an alternative to getting capital. P2P platforms solved this problem by providing an alternative to banks. In the following years, crowdlending platforms emerged all over the world. Some governments were willing to encourage the development of this activity in order to compensate for the shortfall of financing through traditional channels.
In countries all around the planet has sprung up to service billions of loans to countless borrowers. Many borrowers, as well as lenders, prefer crowdlending over traditional banking services.
Crowdlending in the European Union
Nowadays, most crowdlending platforms in the European Union are based in the Baltic republics. The Baltic states, which comprise Estonia, Latvia, and Lithuania, have been successfully creating an environment of entrepreneurship, digital penetration, modern technologies, and international talent, which have established them as a vibrant and innovative location for Financial Technologies (often shortened to FinTech or fintech) companies.
Advantages of P2P Lending
Some of the advantages of crowdlending are:
- Steady Stream of Income: P2P Loans can generate fixed interest income for investors. P2P loans are generally paid back to the investor’s account on a monthly basis, including a part of the principal invested and the interest accrued in the month.
- Higher Returns: P2P Lending provides higher returns on savings when compared with leaving them sitting in the bank or investing in products offered by Banks.
- Compound Interest: Most crowdlending platforms have an automated way for the investor to reinvest his money. The interest gained will start generating returns as soon as deposited into your account. And so on. As an example, let’s imagine you invest 300€ every month in a crowdlending platform, in loans which have an 11% interest rate. In ten years, your total investment will be worth:
- Diversification: P2P Lending allows investors to choose what projects or personal loans they want to invest in. In addition, you can choose the term, amount, risk and, therefore, the likely profit. The principle behind crowdlending is to source a loan from a ‘crowd’ of many investors, each contributing a small proportion of the overall amount. By committing only small amounts to anyone loan, investors can spread their overall risk.
- Ease of Use: Creating an account and transferring money into the account is a very simple, streamlined process. Investing in loans is also as easy as clicking a button or 2.
- No or Low Fees: Generally there are no fees associated with investing in loans.
Is crowdlending safe?
Every business or investment have a risk. The main risks in crowdlending investments are borrower default (the borrower doesn’t pay back the money); loan originator bankruptcy (the loan originator goes bankrupt) and platform bankruptcy (the P2P lending platform goes bankrupt).
At the moment most crowdlending platforms offer buyback guarantee. So if the loan borrower is not paying back the invested money, the platform will buy back the loan and usually pay the investor the interest for this time period. I exclusively invest in crowdlending platforms that offer buyback guarantees. Some platforms offer loans both with and without buyback guarantee. So, make sure to choose the loans with a buyback guarantee to have an extra layer of security. What is more, you should always lend in small amounts and to as many borrowers as possible to spread your investment risks. Acting this way, you can be almost sure a single borrower default won’t wipe out all of your invested funds at once. I usually invest no more than 15-20€ in a single loan.
Loan originator bankruptcy
Most P2P lending platforms offer loans from different loan originators (e.g. other companies facilitating the loan process with the borrowers). There’s a risk one of them might default and so you can lose your investment, too. In the case of loan originator default, the P2P lending platform typically takes over and try to recover the investment through normal bankruptcy procedures. To mitigate the risk, you should investigate and only invest in loan originators you are comfortable with. And diversify your investment across multiple loan originators.
Crowdlending platform bankruptcy
Maybe the major risk when talking about crowdlending investments is p2p platform bankruptcy. In case a crowdlending platform you invest in goes bankrupt you risk losing all your investment. Once again, in order to mitigate the risk, the only advice is to research and diversify. I only invest in a platform after having made careful research. I read all the news I can find about it and other investor’s reviews, and always check the teams behind.
Nowadays I invest in 9 different platforms, and I’m planning to increase the number soon. Thus, I minimize the risk associated with platform bankruptcy.
I hope by now it has already made clear what is crowdlending. But if you have any question, please do not hesitate to ask it in the comments. You can also take a look at my current crowdlending portfolio.