Peer-to-peer lending has become popular in this low interest rate economy. But with higher interest comes higher risks. Do you know the disadvantages of investing in P2P loans?
Risk of default. One of the main disadvantages is the risk of default on the loans. There are no guarantees that the borrower will repay you in full. The best way to offset this risk is to invest in a diversity of loans that are in the A and B ratings range.
Unsecured loans. This accompanies the risk of default. There is no collateral backing these loans. It is harder to collect if the borrower defaults. The websites that offer P2P loans do have collection services, but the risk of losing your money is still high.
Multiple loans. As stated above, to offset default risk, it is necessary to spread risk over many loans. This can become inconvenient to keep track of and manage all your loans.
Lock in money. Loans are often issued for three to five years. This locks up your money. You lose access to the money during this time. You will be receiving payments each month. But if you need the bulk of your money for an expense, you will have to sell it on the trading platform.
Trading platform fees. The trading platform is where you can sell your loan to fellow peers. You incur fees to trade. Whether there is a fellow lender willing to buy your loan is another question.
Loan fees. The websites who administer the P2P loans charge a fee to for this service. They will state their fee and provide information on how this alters your potential return.
P2P sites’ health. You have to trust that the P2P website that you are doing business with will stay in business. There are supposed to be backup servicers who will take over if a site goes out of business. Information on this is available on the P2P websites.
Miss out on rising interest. There is the risk in a low interest rate economy that rates will start to rise. You run the risk of missing out on higher and safer rates while your money is locked in these loans.
Availability. Loans are not available in all states. Kansas, Maryland, Ohio, Oregon, and Vermont are a few states that do not allow their residents to invest in P2P loans. Check on each lending site or with your state government to find out if your state allows P2P lending.
Taxes. P2p loans are taxed as ordinary income. You will want to factor in the cost of taxes when considering these loans.
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