We all need small loans at some point of time or other. Most of us ask their friends or family members to support them. However, this is not a comfortable option for all and there aren't any legal obligations if the borrower is unable to repay. Here P2P lending platforms are a savior.

What is a peer-2-peer lending platform?

Peer-to-peer lending is a form of crowd-funding used to raise small loans for a qualified set of people from diversified portfolio investors. It enables individuals to borrow and lend money without any financial institution as an intermediary, thus reducing transaction or management fees. The main idea is savers getting higher interest by lending out their money instead of saving it, and borrowers getting funds at comparatively low interest rates. All P2P platforms will now be considered non-banking financial companies and regulated by the RBI. (NBFC-P2P)

Although it’s a new concept in India, this is much more prevalent in the US and UK from 2005 onwards. It’s less volatile and much safer than stock markets.

Reasons to Consider When Investing Via P2P Lending

Besides traditional savings and fixed deposits, real estate investment and gold, in order to diversify the portfolio aimed at making high and stable returns, P2P lending is a suitable option. Here are some of the reasons why lenders are considering investing in P2P lending formats:

Double interest than FD: You can earn about 12% interest rate as compared to about 6% on FD without taking much higher risk. Investors usually begin making returns early on, sometimes from the very consecutive month of investment. Repayments with part principal and interest are received by the lender as monthly installments once the loan is taken and starts getting paid for.

Low entry cost: To start building your P2P lending portfolio you do not need huge investments. Entry level cost is low, and a new investor can start at as less as INR 50,000 to INR 1 lakh and slowly increase the portfolio size.

Low volatility: Returns from P2P lending are dependent on the portfolio built by a lender. Unlike other market-linked investments such as mutual funds and systematic investment plans where the returns depend on the performance of the stock market, P2P lending returns are determined at the time of lending to a borrower.

Ease of investment: P2P lending is a digital-first process. This means from narrowing down on borrowers that meet your criteria and signing legal agreements with borrowers to receiving repayments, the process is managed digitally. All transactions are through an escrow account under a third-party trusteeship and the platform via which you conduct the P2P lending activity manages and updates your portfolio’s performance on a real-time basis.

Higher control over investment: The biggest risk in P2P lending is the risk of default. However, unlike risks associated with other market-linked investments, lenders can do a lot to mitigate this risk to have higher control over their investments. Also P2P platforms are RBI regulated and adhere to stringent norms.

The interests earned can be automatically reinvested for higher returns:

Automated Investment

This process helps investors to divert funds to auto-invest wherein the platform’s algorithm automatically finds borrower profiles that match their investment goals. It reduces time in direct management and also ensures steady capital growth.

Systematic Portfolio Management

Here investors pool their money to build and manage portfolios with the potential of delivering high and stable returns. All investors have to do is add the money to their account and permit the platform to allocate the funds using data analysis to provide higher aggregate returns.

P2P lending has emerged as an alternative to traditional bank lending, and it comes with the following advantages:

Get a quick low-cost credit because of the lack of intermediary costs.

The application process is also easy and quick unlike banks and NBFCs which take 4-7 working days to disburse a loan.

Borrowers with lower credit scores or self-employed can borrow on these platforms.

What are the restrictions?

RBI has put a cap on the aggregate exposure of a lender or the maximum that one may borrow at any point of time, across all P2Ps, is capped at Rs 10 lakh. Even the exposure of a single lender, across all P2Ps, shall not exceed Rs 50,00,000 and the maturity of the loans shall not exceed 36 months.

The P2Ps should obtain a certificate from the borrower or lender stating therein that the borrowing and lending limits are adhered to. A P2P lender cannot lend on its own, cannot provide or arrange any credit enhancement or a credit guarantee. A P2P lender cannot lend on its own, cannot allow an international flow of funds or cross-sell any item except for loan-specific insurance products.

Risks:

Risks for a lender

All investments involve risk. However, in comparison to equity or commodity market investments or real estate, P2P lending has lower risk as it is addressed by on-boarding high quality borrowers. Further, lenders are suggested to create a diversified portfolio of loans. There are over 105 stringent checks are carried out to identify and match the right borrower profiles.

Risks for a borrower

Defaulting borrowers can end up hurting their credit scores thereby lowering their chances of securing loans in future. Plus, there can be steep penalties for delaying or defaulting on the payment and it may involve a long drawn litigation process,

For an additional fee, P2P platforms can offer you third-party legal opinion. The P2P platforms try to recover the defaulted amount, including steep penalties charged thereon by deploying their own human resources for no additional fees. The P2P platforms have the recovery process in place and one should understand it before using the services of the platform.

Final Thoughts

P2P lending is a way of being able to unlock individual credit supply blocked in low-yield investments and shift it to an asset class that could help you earn higher returns similar to that of a bank.