As compared to other forms of investment, peer to peer lending is most often considered riskier. Why is it so risky? Why are people still lending if it is so risky? You’ll know the answers below so read on.
In peer to peer investing, the overall risk is based in the nature of the loan that is issued. The loan is unsecured which means that it has no real collateral that backs up the loan but only a promise that the loan will be paid by the borrower.
Peer to peer lending is not the only type of unsecured loan today. In fact, every credit card is unsecured loans too. These lines of credit carry high interest rate. The reason to this is because they are unsecured. Same is true with peer to peer lending.
So how risky are peer to peer lending? Often, they can carry the same risk that credit cards carry. The risk of late payment or non-payment is always there but lending institutions take steps to reduce those risks.
First of all, they make sure qualification of borrowers are well reviewed. The qualification for borrowers include credit check. The borrower’s credit history, credit score, utilization, employment and other necessary factors are all reviewed by the institution to assign a grade to the borrower’s loan. If they don’t meet the standards, then their loan request will be rejected. Often, these are posted for the investors to review. This gives them the assurance that the institution is doing their job.
Second, important information about the borrower’s background and credit check is also posted with the loan request. The lenders can also review these information and decide whether they will invest on a particular loan request or not.
And third, the lenders are not required to invest in just one loan. This is where diversification comes into picture. Diversification means to spread his money across as many different loans as possible. The diversification effect will help reduce the risk to the lender. It is important to diversify unless you can afford to lose money in your investment. The risk of default in this real world can be drastic. Diversifying the loan portfolio is the only sure way to protect the investor against default risk.
The big question is still why do investors keep on investing in peer to peer loans when there is a high risk? It is simply because the returns are very high. The risk is always present in any form of investment, but the investor needs to take the right steps to avoid those risks. Finding reputable site for peer to peer lending will reduce the risk on the part of the investor. They will ensure that proper background checks are performed and borrowers at high risk are rejected. And to further reduce the investor’s risk, they should diversify their holdings of loans. For most lenders, the risks were outweighed by returns and makes it a feasible investment.