The peer-to-peer marketplace 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 back paid back your principal (original amount) plus interest by the borrower.
Also, you’ve probably heard your friends or colleagues chatter about peer-to-peer lending sites (like Lending Club) or real estate crowdfunding sites (like Fundrise).
Here’s my take on these sites, including their EXACT pros and cons from a cash flow and tax perspective.
Whey Peer-to-Peer Lending?
For many folks, the best way to empower ourselves is to become financially free. It will let you life live 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 new income streams. 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 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.
High Returns
Compared to other investment options, you can get a great return with peer to peer lending. On average, you can expect to get about a 10% return on your investment.
So, if you invest $1,000, you’ll end up with $1,100 at the end of the loan repayment process. Although this may not seem like a lot, the more you invest, the more you’ll earn in interest every month and the more you’ll end up with.
Additionally, if you can make 10% on your money, your money will double approximately every 7.2 years. This is how you can get your wealth to snowball, by turning $1000 into $2000, $2000 into $4000, $4000 into $8000, and so on.
As described in this powerful example by The Balance:
To provide a stark illustration, $10,000 invested at 10% for 100 years turns into $137.8 million. The same $10,000 invested at twice the rate of return, 20%, does not merely double the outcome, it turns it into $828.2 billion.
It seems counter-intuitive that the difference between a 10% return and a 20% return is 6,010x as much money, but it’s the nature of geometric growth.
Finally, one mindset that the wealthy have is that they nearly always 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.
Secure
Another thing that sets peer to peer lending investments apart is that it’s more secure than other methods. Investing in gold, for example, is unreliable as the price is always fluctuating and could drop at any moment.
Likewise, choosing the wrong stock option could end up losing you a ton of money. However, because of the way peer to peer lending is set up, it’s one of the safest 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.
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.
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.
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.
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 6 Peer to Peer Lending Sites
Although there are many different peer to peer lending sites that have popped up, here are six of the leading ones to consider, 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.)
While StreetShares is another option for peer-to-peer lending, I don’t like that they pay out only a 5% return. In my opinion, that rate of return is too low for this type of investment vehicle. Their pitch is that 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.
Options for Peer-to-Peer Lending in Real Estate
Another twist on this theme is to apply peer-to-peer lending within the real estate market. One of the better known companies within this realm is Fundrise, which lets you invest in private real estate deals earning historical annual returns of 8.5 to 12.5%.
Personally, I would prefer that you learn to directly invest in real estate, because real estate funds like FundRise limit the tax advantages that you can receive. Withing these funds, you usually cannot deduct mortgage interest or take depreciation deductions, which can be substantial when you own large properties. You also can’t do 1031 (tax-deferred) exchanges when a property is sold.
In contrast, when you directly invest in real estate, you can execute a 1031 exchange, thereby deferring your tax obligation to later point in time.
A 1031 exchange is named after Section 1031 of the IRS code, and it allows you to defer paying capital gains taxes when you sell an investment property by reinvesting the proceeds from the sale into like kind properties of equal or greater value. It is a powerful way to defer your taxes into the future.
While 1031 exchanges are frequently used by wealthy, the exciting news is that this tax benefit is available to anyone who is familiar with this section of the tax code.
On the upside, if you do not plan to directly invest in real estate, then funds like Fundrise represent a thoughtful alternative that will pay a relatively strong rate of return, while securing your investment with a hard asset (real estate).
Other alternatives to Fundrise include Realty Mogul, RealtyShares, Patch of Land, Peerstreet, and others.
Real Estate Crowdfunding: REITs not Real Estate
The main thing to know about crowdsourced real estate funds are that you’re usually investing in a Real Estate Investment Trust (REIT) and not directly investing in the real estate itself.
In short, a REIT is a piece of paper, not a hard asset like real estate.
Unfortunately, U.S. security laws currently limit many of the best investments to accredited investors. The term “accredited investor” is described within Rule 501 of Regulation D of the U.S. Securities and Exchange Commission (SEC).
Accredited investors are people who have a net worth of $1,000,000 or more (with your primary residence excluded) or who make at least $200,000 per year for two years in a row. If I’m being blunt, a good synonym for accredited investors would be rich people.
Fundrise and its peers use the REIT structure to get around the accredited investor laws, allowing people to buy into a portfolio of properties, often for as little as $1000. However, there is a downside to this, which is that you lose most of the tax benefits associated with directly buying real estate.
For this reason, I have mixed feelings about these type of crowdsourced real estate funds.
The upside if that you can get strong returns (often 8.5 – 12.5%) and create new flows of passive income.
The downside is that you lose many of the powerful tax advantages associated with buying real estate directly, such as writing off mortgage interest, taking depreciation deductions, and doing 1031 exchanges. Often, these tax benefits can massively decrease your tax burden, and in some cases, eliminate it entirely. Meaning, it’s a bummer to lose them.
Grant Cardone’s Real Estate Fund
Real estate mogul Grant Cardone will also let you partner with him on large apartment deals too through his fund, Cardone Capital. I mention this because Grant has done something extremely rare. He let’s you directly own a share of his real estate deals.
Meaning, with his fund you are directly investing in the hard assets (apartment complexes) that he buys.
For this reason, when you invest with Cardone Capital, you get issued a year-end tax form called a K-1. When you invest in a real estate deal like this, your cash distributions are usually not subject to federal income tax the way that they are with a REIT.
Of course, Grant offers real estate funds for accredited investors, because these are relatively easy to create from a legal perspective. However, he also established what is called a Regulation A+ Fund, which meant that investors in it do not need to be accredited (wealthy). Because this type of offering is extremely rare, he fully funded it earlier this fall.
In September 2019, Grant Cardone officially closed the doors on his Cardone Equity Fund V, the first Regulation A+ fund of its kind to raise $50 Million in crowdfunding using social media and audience of followers and clients.
This means that until Cardone Capital decides to open up a new Regulation A+ Fund (and gets approved to do so by the U.S. SEC), you’ll need to be an accredited investor to partner with him and you’ll need a minimum of $100K as an initial investment.
Downsides of the Peer to Peer Marketplace
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, than 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.
Want More Passive Income Motivation?
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 decent rates of return with a minimal investment of time.
In short, here’s a financial breakdown of what investment types will benefit you most:
- Best Option: Form Businesses and Directly Invest in Real Estate. (*You get incredible tax advantages and can potentially multiple your money 2X, 3X or more.)
- Reasonably Good Option: Peer-to-Peer Lending and Crowdsourced Real Estate Investing. (*You get a reasonably strong return, the money you earn is usually taxed a lower rate than your earned income, and you acquire a passive income stream.)
- Worst Option: Keep Your Money in the Bank. (*This is a terrible option, because your money will decay each year at the rate of inflation.)
Of course, there other investment options too, such as the stocks, mutual funds, ETFs, bonds, certificates of deposit (CDs), tax liens and more, but I will have to get into those subjects in a future post!
If you’re still not sure you what to do next, I would suggest that you read Rich Dad, Poor Dad, because it is one of the best financial literacy books of all time.
Have we connected yet on Instagram? If not, lets do so because I want to share in your life too.
Do you have questions about using peer to peer lending? Ask them in the comments below and I’ll share answers.
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