Risks of Peer to Peer Lending?

The biggest risk that stands out for me is if a borrower fails to pay back the loan.  If it’s just late payments then you are delayed in receiving your capital and interest returns.  However if the borrower defaults, you capital is at risk.  Depending on if the loan was secured or unsecured and what protections and procedures are in place regarding debt recovery with your investment platform you may lose your money in that loan.  Some platforms have a provision fund to help cover defaults, but this money is not set up for free.  It comes by reducing the interest you receive from your investment.  From the Product Disclosure Statements (PDS) I have read, it is also not guaranteed that losses will be paid of any provision fund a provider may hold.  It is also important to note that money invested into Peer to Peer lending is not considered a deposit and thus not covered under Australian depositor protection laws.

In my opinion, the best way to minimise the risk of default is to diversify into more loans by reducing your loan size into each loan.  Depending on the platform it could be as low as $10 into in a single loan.  Note loans will have different risk ratings with risker loans (unsecured or the low credit ratings) typically have a higher interest rate to compensate for the higher risk of default. 

In Australia it is worth checking if the provider has an Australian financial services (AFS) licence.  This can be checked on the online at Australian Securities and Investments Commission.  This is important as it ties in with their legal requirements on responsible lending of credit.  It means they credit assessments have a minimum standard to be meet and helps reduce the risk of loan default. 

It is also important to note that credit assessments are only a snap shot in time when the application is first made for the loan.  Future circumstances may change which could affect a person’s ability to pay back the loan.

Another important risk from a personal point of view is that money invested should be considered fairly illiquid, as you are essentially providing capital for the life of the loan.  Each provider is slightly different in how it works, so it is important to know what you’ve committed to.  Some providers offer the ability to sell your remaining loan investment to other investors but again you need to check if the provider offers this and what the terms are.  In the case of the ability to sell you loan portion, you still need a willing investor to buy out your stake in a loan for you to receive your capital. 

What happens in the event of the provider going out of business?  Although I see this as a very low risk, it needs to be considered.  Each provider might have a slightly different way of handling it so it is important to have a read through the PDS to understand how it will be dealt with in that unlikely scenario. 

While I’m sure there are other risks, these are the main ones I’ve identified in my journey to date.  I’ll continue to compile these and share them as I go along.  As always historical performance does not guarantee future results.  Keen to hear what other risks people have identified.