P2P lending has taken off in a big way in recent years. The way it works is simple, you lend your money directly to borrowers thus bypassing banks. Instead of the banks making big bucks lending your money, you do. In this article, I explore the pros and cons and explain how to start lending.
The pros and cons
It’s pretty hard these days to find a solid bank that will pay a decent interest rate, on major currencies it’s almost impossible. Peer to peer lending on the other hand allows savers (lenders) to bank returns of 5-15% consistently and with a reasonable risk/reward ratio. Obviously, there are no guarantees that you will make the promised return but so far almost all medium to large lenders have made a positive return.
Peer to peer lending is more than just an investment product, it’s an opportunity for location independent individuals to put their money where their mouth is. We tend to be vocal about free market and if done right, peer to peer lending can be the perfect engine of growth in a free market. It allows people with creative ideas and talent to get funding and people with money to get high returns, all of that without interference from the banking sector.
You should always ensure that your investment portfolio is diverse and that the correlated risks are minimal. Peer to peer lending is relatively safe as it allows you to spread your investment over a vast amount of borrowers. It is unlikely that all your borrowers will default even in the event of a major financial crisis.
Lending money in various currencies can be a major risk element to your portfolio and can lead to losses even if you made a positive return in your lending currency.
Most lending companies are in high tax countries and as a result, lending comes with a heavy compliance cost as well as a potential tax bill. Currently, to lend in the United States or the United Kingdom you need to register a local company and that can be a drag on your profitability unless you lend vast amounts.
Peer to peer lending isn’t as safe as just putting your money into a savings account, there are no guarantees that you will ever get it back. As a lender you are incredibly exposed to anything happening in the country in which you lend.
Lending Club was founded in 2006 and is the largest lending company in the world. They offer high returns and have a low default rate. It is important to note that the notes issued by Lending Club are their ultimate responsibility and not that of the borrower. As a result you could potentially lose all your investment if Lending Club becomes insolvent or declares bankruptcy, even if the borrower continues to pay.
Prosper is quite similar to Lending Club and is the second largest player in the American market. They offer similar returns but their default rate has historically been higher. As is the case with Lending Club, the notes issued by Prosper are their ultimate responsibility and that comes with the risk of losing your entire investment if the company becomes insolvent or declares bankruptcy.
Zopa is the oldest peer to peer lending company in the world. It is my favourite platform as the risk of losing your investment is nil due to the notes being insured. The UK government uses the platform to lend to sole traders giving it more legitimacy.
RateSetter works like an exchange with borrowers and lenders competing for matched loans based on price with both sides specifying the rate they will accept. As is the case with Zopa, the UK government uses the platform to lend to sole traders.
Based in the United Arab Emirates, Beehive allows anyone (even non-residents) to lend money to established U.A.E. companies. It is a great option for those who want to lend through an offshore company. There is no income tax or capital gains tax in the U.A.E. and as far as I know Beehive is the only truly tax-free peer to peer lending platform in the world.
In order to lend in the United States, United Kingdom and many of the other developed countries you need to be a local resident and have a local bank account. It is, however, possible to bypass the residency requirement by registering a local company and using a business bank account to fund your loans. I recommend registering an LLC in Wyoming as it is the most advantageous corporate vehicle for peer to peer lending in the US. For the UK, I recommend using an LLP. Be aware that you will almost certainly need to visit the US or UK to open a business bank account and that you will have to meet ongoing compliance requirements for as long as the company is active.
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