P2P loans involve a considerable amount of risk both to the lender and the borrower. Although there are a number of ways of mitigating risk, there aren’t sure methods of avoiding loss of capital invested in such ventures. Below are some of the risks involved in peer-to-peer lending:
This is the biggest risk posed to investors who engage in this kind of investment. Borrower default happens when the borrower does not repay the loan advanced hence the lender’s capital is at risk. Note that the venture relies on the principle of matching savers of money with borrowers i.e. savers who are looking for a better return on their money meet with borrowers who need a loan at a fair interest rate. This risk has led companies to advance secured lending where the borrower has to attach an asset or property equal to the loan advanced by the lender. Therefore if the borrower defaults in payment the attached asset is sold to recover the loan amount. Only traditional peer-to peer-investing companies would advance loans without collateral.
Insolvency of the operator
P2P lending ventures are normally operated by companies on behalf of the lenders. Such companies may become insolvent such that they are not able to manage borrower repayments effectively. To avoid loss of the lender’s money through such scenarios, certain precautions are taken by the operator
- Money that is not for loan advancement is held in separate client money trust account.
- Security provided by the borrower in case of default is held by an independent trustee, separate from the operator.
Changes in prices of the property
The global market continues to change, especially in the realm of real estate. Therefore secured loans attached against property may be affected in case remarkable changes happen in the property market. In such instances some companies may take liability for any loss that may occur in the event the attached property has lower returns than the loan advanced.
Interest rate risk
Just like loans advanced by banks interest rates are bound to reduce or increase once in a while. Lenders are therefore advised to consider this factor before committing any funds to a loan since they would not be able to move capital on loans earning higher interests until the current loan matures. It may not be a major risk but it’s definitely worth factoring in. Lastly P2P investments are not always entitled to compensation in case of any loss. Therefore lenders risk losing capital invested in case of any loss.
Any lender who wants to venture into such investments should make an assessment of such risks before attaching capital with the lending companies. A careful analysis of all such factors will help an investor make a wise decision.