Peer lending is a form of portfolio income that can earn you interest on your investments. It is a bit different than other high yield investments such as certificate of deposits, dividend stocks, and savings accounts. Lending money to your peers, also known as micro loans, can prove to be a viable passive income stream provided you understand the risks and rewards.
What is Peer Lending?
This alternative form of lending brings together individual investors and borrowers through a common platform (i.e. Lending Club). Borrowers looking to consolidate credit or find other financing submit a loan request for the amount they are looking to get financed. Lenders then bid on funding a small portion of the entire loan at a particular rate. Think of it kinda like eBay for lending.
While there are many other details of peer lending not discussed here, the basic fundamentals bring together those looking for capital with investors. The investor gets a higher rate than traditional investments, the borrower gets the funding they need, and the peer lending institution takes a percentage off the top from the transactions.
So what are the pros and cons of peer lending?
Why Peer Lending?
As an investor or someone looking to build passive income, peer lending has several advantages and disadvantages. Before you decide to start investing money into micro loans, be sure to know the risks and rewards that accompany this income opportunity.
Advantages of Peer Lending
There are plenty of reasons why peer lending can be an attractive investment. Here are a few advantages of why peer lending can be a legitimate passive income opportunity.
- Interest Rate – The rate of return on funding a micro loan far exceeds that of a certificate of deposit or high yield savings account. Depending on your risk level, you could legitimately earn anywhere from 8% – 14% return on your investment. While there are some associated risks when investing in micro loans, a double digit return is very hard to ignore.
- Diversification – People who invest in micro loans have the ability to choose the loans they bid on in order to create a diversified portfolio. That means you can structure the micro loans you fund based on the risk level and rate of return you are looking for. This gives the investor a lot of control in the portfolio they choose to create.
- Help Others – Peer lending is a nice investment option as it allows you to help others out who may not be eligible for a traditional loan. Banks have tightened their lending standards, so those no longer eligible for funding can turn to the peer lending industry to get capital. There are even some peer loan institutions that offer loans for people in third world countries that would have no other options available to them.
Disadvantages of Peer Lending
Just as there are reasons why peer lending can work, there are plenty of risks and disadvantages to setting up this type of passive income stream.
- Not Insured – The money that you invest into funding micro loans is not FDIC insured. This means that there is no guarantee that you will ever see your investment dollars again once you fund a portion of a micro loan. If the borrower decides to declare bankruptcy and is delinquent in paying off the loan, there is not much you can do about it.
- Limited Availability – In the US, because of various state laws and regulations, peer lending is not available to everyone. Before you get set to start lending out money to your peers, make sure your state will allow these investments.
- Requires Ongoing Maintenance – When comparing investments that earn interest, peer lending is one that is more time consuming than others. Building a solid micro loan portfolio can require ongoing maintenance which makes it less passive than a high yield savings account or certificate of deposit.
Peer Lending Resources
While there are several peer lending companies popping up all over the place, there are two that seem to be the most popular. Here are two options that you can use to begin building your peer lending passive income stream.
- Prosper
- Lending Club
- Peer Lending – Mid Year Review (2009)
- Get Passive Income With Lending Club
- Creating a new Income Stream using Prosper
- My Toxic Assets
- How to Jump Start a Passive Income Stream
Lending Club is offering a great deal for new investors who sign up with them. For any new lender who opens an account, they will receive $64.62! Why $64.62? Because banks made $6.462 billion dollars last quarter and Lending Club is trying to promote peer lending as an alternative to traditional lending. If you are interested in signing up, contact me and I will send you an invitation through email. Please note that I do not receive any commissions for this deal.
Final Thoughts
I started a peer lending income stream several months ago. Over that time I saw a return on my investment push into double digits only to see the recession hit and my portfolio of loans go down with it. Since the time the economy started to falter, I have had more micro loans become charged-off (go into collections) instead of paid off. As a result, I have actually lost money on this investment.
Do I think that peer lending is still a viable option? Absolutely. Provided you diversify your micro loans and make peer lending only a small portion of your passive income portfolio, I believe it can be a great opportunity.
Do I still participate in peer lending? Unfortunately, the state that I live in no longer allows me to fund any new loans. As a result, I only have investments in previous loans and cannot add any additional money to this income stream.
How successful have you been with setting up a peer lending income stream?
Related posts:
Related posts brought to you by Yet Another Related Posts Plugin.
{ 7 comments… read them below or add one }
I guess I’ve been lucky with my loans. I’m currently making an 11% return at Lending Club even though one of my loans was charged off. I only have a couple of loans at Prosper and one of them was paid early but I will still have a decent return.
I’ve been debating whether to invest any more money in these. You can make a lot more money with P2P loans than savings accounts but you are taking a lot more risk. I’d like to think that I’m really good at picking loans but it is probably more that I’ve been lucky and that can’t last forever.
@Andy – 11% is great, especially with the charge off. It is hard to tell about picking loans. I though I was diversifying really well with my Prosper loans, yet I have had several ‘A’ grade loans go into a charge-off status.
I love prosper! I have had only 3 charge offs in my 2 years of investing, and those were created 2 years ago.
@Evan – What type of return are you getting with your loans?
I think to be successful you really have to diversify (that whole portfolio theory thing) and spread the risk around. This means pumping a lot of money into one of the lending venues. On the bright side, Prosper has recently lowered their minimum lending amount to $25 which makes it easier to get that diversification.
@Reed – I didn’t even realize Prosper lowered their minimum to $25. I think that is a good move and helps investors diversify even more.
Peer lending is popular in the UK, and there’s a website that allows you to do it – it’s called Zopa. I’ve been lending out money at around 8-10% (before fees and tax).