Peer-to-peer lending involves the act of lending money to other people or businesses in exchange for receiving interest on your money.
Basically, you’re acting as a bank and giving out a loan on which you are paid back your original amount, called principal, plus interest by the borrower.
You’ve probably heard your friends or colleagues chatter about peer-to-peer lending sites, like Upstart, Lending Club, or Prosper. Here’s my take on these sites, including their pros and cons from a cash flow and tax perspective.
Why Peer-to-Peer Lending Platforms?
For most people, one of the most empowering thing you can do is to become financially free. It will let you live life on your terms, free from the expectations of others.
One of the investment vehicles that can be a smart fit for people who want a passive income option is peer-to-peer lending. It’s simple, it’s straight forward, it pays you monthly, and you can get started with a very small amount of money.
Plus, nearly all millionaires have multiple streams of income. On average, millionaires have not just one, but 7 streams of income.
To create financial freedom, you need to learn how to generate multiple streams of income. An interesting way to earn passive income is through the peer to peer marketplace. It’s all about working smarter (not harder) and getting your money to work for you, rather than the other way around.
What is Peer to Peer Lending?
To begin, let’s define what peer to peer lending is.
Essentially, peer to peer lending allows someone to take out a loan that’s funded by their peers rather than a bank. Then, as they pay back the loan, the lenders collect interest every month.
This allows people with all types of credit to borrow money at lower interest rates than they would typically get from a bank. Furthermore, some people who may not be able to get a bank loan can get one through a peer to peer marketplace.
From an investment standpoint, peer to peer lending allows you to (relatively) safely lend your money to people who need it and earn interest off of it. You get the satisfaction of knowing you helped someone in need while gaining benefits yourself.
Benefits of Lending in the Peer to Peer Marketplace
There are numerous benefits to choosing peer to peer lending as a way to get passive income. Let’s look at a few of them here.
1. Cash Flow
With peer-to-peer lending, you get paid cash flow in the form of interest payments from your borrowers. Cash flow is the only way to achieve financial freedom (or quit your job), because it is what pays your bills on a month-to-month basis.
2. Strong Returns
Compared to other investment options, you can get a strong return with peer to peer lending. On average, you can expect to get about a 10% return on your investment.
This rate of return is substantial, because if you can make 10% on your money, then your money will double every seven or so years. This is how you can get your wealth to snowball, turning $1000 into $2000, $2000 into $4000, $4000 into $8000, and so on.
A common mindset that the wealthy have is that they typically seek a 10% (or greater) return on their money. In contrast, many lower and middle class people will accept lower rates of return, often because these are the only investment vehicles that they can easily access.
By increasing your financial education, you can break this cycle and claim increasingly higher rates of return for yourself as you learn about different types of investment vehicles and the risks associated with each.
Another thing that sets peer to peer lending investments apart is that it’s a relatively secure investment. Investing in stocks, for example, may work out over long periods of time, but the price is always fluctuating and history has demonstrated that catastrophic market drops can happen.
In contrast, because of the way peer to peer lending is set up, it’s a relatively secure investment options.
This is because you don’t have to rely entirely on the individual paying back the entire loan. If they do default on it, the website you’re going through has a collection process in place.
4. Spread Risk
Part of your investment strategy should be to spread the risk to limit the chances that you’ll have to deal with someone defaulting on a loan. Peer to peer lending marketplaces make this easy by allowing you to invest in numerous loans.
Many websites allow you to invest as little as $25 in each loan.
This allows you to invest in dozens of loans with a small amount of money every month. That way, you won’t have all of your eggs in one basket, although you certainly do this if you find a loan with a strong rate of return and a healthy probability of repayment.
5. Control Over Investments
You can also look at the overall credit score of each person before committing to lending them money so you know how risky the loan will be. If you don’t want to participate in high-risk loans, then you can choose lower-risk options.
You can also search for loans based on someone’s work history, loan repayment history, or even what they’re using the money for. With greater control, you can know you’re picking the right loans for your investment strategy.
Something to keep in mind is that the lower-risk loans generally come with a lower interest rate. This means you may only get a 6% return on your investment.
In most cases, it’s a good idea to invest in a variety of loans. You’ll get an overall higher rate of return while keeping your overall risk limited.
6. Low Entry
While some types of investment require you to have hundreds or even thousands of dollars to get started. Real estate, for example, is a great way to earn passive income but the high cost of entry can make it difficult for some people.
Most peer to peer lending websites will allow you to get started with just $25 to $100. From there, you can continue to add money and watch your investments grow.
Besides not needing to invest a large sum of money, there are also no fees to deal with. When you deposit $100 into your investment account, that’s exactly how much you can invest.
7. Easy to Reinvest
As easy as it is to get started, it’s also incredibly easy to reinvest as loans are repaid. After a while, you’ll have enough money coming in every month that you can reinvest in new loans without adding extra money.
All you have to do is log into your account where you’ll see how much money you have available and then start searching through the loans to reinvest it so your money keeps growing.
I recommend doing this along with adding money every month as a long-term investment strategy. Reinvestment allows you to earn a return on the interest you earned, making each dollar worth even more.
Top 7 Peer to Peer Lending Sites
Although there are many different peer to peer lending sites that have popped up, here are the seven trustworthy platforms, along with links to check them out:
- Upstart – https://www.upstart.com/
- Prosper – https://www.prosper.com/
- Lending Club – https://www.lendingclub.com/
- Funding Circle (Business Loans) – https://www.fundingcircle.com/us/
- CircleBack Lending – https://www.circlebacklending.net/
- PeerForm – https://www.peerform.com/ (*Note, don’t let the feel of the PeerForm website scare you off. It is a legitimate platform with smart founders, and as an investor, you can choose from over 16 different risk categories.)
- StreetShares – https://streetshares.com/
While StreetShares is a great option for peer-to-peer lending, be aware that they pay out only a 5% return. In my opinion, that rate of return is on the low side for this type of investment vehicle.
However, you can earn this lower return while helping American small business owners by financing Veteran Business Bonds. Given this, it’s up to you if your goal is to optimize returns or support a good cause.
You can also do an online search for “peer to peer lending” to find other options you may prefer.
The Downsides of Peer to Peer Lending
In my mind, the main downside of the peer to peer lending landscape is that it doesn’t have the same tax advantages as running a business (which allows for major tax write-offs) or real estate (which also provides for extraordinary tax advantages).
However, peer to peer lending is both easier and more passive than either of these options, so if what you’re looking for is a low stress option to create new income flows, then it might be just the right fit for you.
Plus, nearly all millionaires have multiple streams of income. On average, millionaires have not just one, but seven streams of income.
Getting Started with Peer to Peer Lending
Now you know some of the many benefits of lending in the peer to peer marketplace. As you can see, it’s easy to get started and you can earn a decent rate of return with a minimal investment of time.
Of course, there are other investment options too ― such as the stocks, mutual funds, ETFs, bonds, certificates of deposit (CDs), tax liens, precious metals (gold and silver), cryptocurrencies, and crowd-sourced real estate investing ― but I’ll have to dig into those subjects in a future post.
Do you have questions about using peer to peer lending? Ask them in the comments below and I’ll share answers.
Peter Opatz says
Lending Club no longer allows notes to be purchased by retail investors.