P2P Crowdfunding for Beginners. Nowadays, people seek the state of financial well-being known as “financial freedom,” and it has become clear that investing on P2P loans is one way to achieve it.
P2P / Crowdfunding investing has grown in popularity over the last years among those looking to invest in their future and generate passive income. But what exactly is knowed as Peer-to-Peer lending (P2P) or Crowdfunfing / Crowdlending?.
What is P2P Crowdfunding lending?
Peer to peer lending (P2P) is self-explanatory, implying that a process moves from one person to another, which it does.
P2P lending is a system that allows people to lend money to others without going through a bank. The middleman is a Peer-to-Peer platform that provides a technical solution and monitors transactions between both parties: a borrower and a peer to peer lender.
An individual investor can acquire or purchase an already issued loan through marketplace lending. This significantly expedites the process and increases the loan supply for potential investors. So, in essence, P2P lending allows an investor to purchase loans that have already been issued by a third party company known as a loan originator.
The P2P platform acts as a go-between for investors and loan originators. Most platforms, have more than one loan originator partnership and just a few platforms only offers loans originated by their group company loan originators.
The P2P industry has expanded in terms of products available. Loans to private individuals are not the only investments available to an investor; investments in collateral backed mortgages, student loans, invoice financing, small business loans, for example, are also available.
Nonetheless, while these business models can be complicated, and the variety of products available can be confusing to a potential investor, the main functionality remains clear—offering an opportunity for everyone to invest in loans.
How profits are made in P2P investments?
Some may wonder, “How can I profit from investments in P2P loans?”
Let´s use an example: The borrower receives a 1.000 EUR loan for one year at 30% interest, which means that it must repay 1.300 EUR.
This loan is made by a loan originator as a financial institution using their own money. The company requires a quick increase in loan issuance, but 1.300 EUR is locked in for a year.
Here comes peer-to-peer lending. The loan originator lists claims on this loan for sale on a P2P lending platform, promising an investor 12% per year. P2P platforms provide the necessary technology for such processes while taking a 3% cut.
An investor pays 1.000 EUR for a loan and waits one year. At the same time, the loan originator receives 1.000 EUR, which can be distributed to new clients. It is beneficial for all parties involved.
If a borrower repays and everything goes smoothly, investors receive 1.120 EUR after a year, 1000 EUR principal + 120 EUR interest, while the loan originator receives 150 EUR = 180 EUR – 30 EUR (fee to the platform).
What if a borrower doesn’t pay back?
This could be the case, and an investor now owns a loan.
It means that risks are transferred from the lender to the investor, but the majority of lenders offer a buyback guarantee.
They guarantee that if a payment is late (usually 30, 60, or 90 days), they will pay back principal and interest to the investor, thereby purchasing the non-performing loan and dealing with a non-paying borrower themselves.
While a buyback guarantee sounds appealing, investors should also consider the ability of loan originators to buy back a loan. Loan origination would not have enough funds to buy back all of the loans in the event of thousands of late monthly payments.
Nothing is guaranteed, that is for certain. For example Lendermarket, a platform that was basically working under Credistar Originator loans (same owner), suddenly on 2023 decided unilaterally, increase their buyback period from 60 to 240 days, and even after reaching the 240 days they are repaying very late to their investors.
For this reason, it is crucial to pay attention to the evolution of investment platforms and their loan originators. Monitoring progress of each player is important, which is why one of the most sougth-after services among our clients, within our consulting services, is helping them create their investment portfolio. Additionally, keeping them informed about market developments is essential for them, to adjust their investments and quickly divest in case of early signs of liquidity problems or operational risk from the various involved parties.
What other risks investors should be aware of investing on P2P loans?
It is important to remember that the P2P lending model has three main elements: borrowers, loan originators, and P2P platforms. Each one entails a unique set of risks. The first one was discussed already. While the potential failure to buy back a loan has already been mentioned, loan originators face additional risks.
Even if an individual loan performs well, loan originators, like any other business, can declare bankruptcy. In the case of a loan originator’s insolvency, an extended period of time is required to receive back invested funds.
When a P2P lending platform advertises and onboards a loan originator, it should do its own due diligence to ensure that the loan originator has sufficient financial resources.
Unfortunately, even P2P platforms are not without risk, and some may even be scam projects that offer non-existent loans and false loan originators on their website. This has been the case in the past.
We inform regularly our customers about market evolution, but each investor should conduct their own research and ensure that the site they choose is safe.
Where should I invest and how much?
We would recommend a few extra steps after an investor has done their own research and chosen the best P2P platform or with our help the perfect portfolio, to customer requirements, had been created.
Loan availability and cash drag
Research on loan availability on the selected platform should be performed. The selected investment amount might be higher than loan availability on the platform. This might be the case more often if an investor chooses to maximise diversification by investing a minimum amount of funds in a maximum number of loans. Cash drag can occur as a result of a lack of research into loan availability on a platform.
A cash drag is a portion of a portfolio that cannot be invested and generates no profits. It could be caused by a limited loan supply.
For example, there are platforms like Swaperwhere the platform itself selects the loans in which to invest the investors’ funds. This can often lead to delays in investing the investor’s funds, leaving them in the account without generating any interest.
Other platforms, such as Peerberry, have recently experienced a much larger number of investors than available loans due to the good results offered to their investors. As a result, investors eagerly await the publication of loans offered for the day every morning, and these loans are typically exhausted within minutes. The outcome resembles a fish market at dawn, where the best pieces are auctioned off to eager customers. Furthermore, the option of automatic investment barely functions due to this scarcity of supply versus demand.
Guarantees and other risk mitigation tools offered by each P2P lending platform vary, as do the characteristics of available loans, fees, and other factors.
Asset liquidity should be carefully considered. If an investor decides to liquidate their portfolio due to financial difficulties or another need for funds, it may take months to withdraw all funds from a P2P platform. This is why the loan terms of available loans must be considered.
Some P2P lending platforms also provide a Secondary Market feature, which allows investors to liquidate their assets more quickly by selling them to other investors at a discount of their choosing.
If the goal is to invest 10.000 EUR and diversify the funds as much as possible, it would take approximately 1.000 manual investments and a few thousand mouse clicks. Because not everyone has the time or patience to do it, P2P platforms provide Auto-invest tools that invest funds automatically based on the preferences of investors.
It should be noted that the autoinvest feature is only available to sophisticated investors on some platforms. A platform will typically ask an investor to complete a questionnaire or test to determine whether or not the investor is professional. Before depositing large sums of money, each investor should ensure that autoinvest is available after completing the full registration process.
Sum it up
Before making a decision, investors should investigate a P2P platform’s loan availability, available tools, fees, and risk mitigation mechanisms. But there’s one more thing: this should be repeated for each platform. It is not advised to invest all funds in a single peer-to-peer platform. Investments should be spread across multiple platforms, not just among different loan originators and loans.
What to do when investment is made, what to expect?
Investing in initial capital is only the beginning. Few loans will most likely be bought back before the end of the initial repayment period. Few loans will be repaid late. Unless the tool is turned off, Auto-invests will automatically reinvest profits and principal repayments in new loans.
Reinvestment risk
In terms of reinvestment, it is only natural for an investor to want to continue the process and reinvest profits. Reinvestment risk should be considered in this case.
Which of the following loans would be more appealing to an investor: the first (1 year term, 12% promised return), or the second (1 month term, 15% promised return)? It could be the second option because it offers a higher interest rate.
An investor could simply take the second loan, receive profits after one month, reinvest them, and repeat this process throughout the year. Unfortunately, for the rest of the year, the best loan available on the market may only have a 9 percent guaranteed return after a month. It means that choosing the first loan was ultimately more profitable. This is referred to as “reinvestment risk.”
Every investor is different. Personally, I like loans to be very short-term and to continuously reinvest. This ensures that compound interest is constantly working for us.
So, by investing for a month, at the end of the month, we will reinvest the same initial capital plus the interest earned for that month, and thus, with each month of reinvestment, the invested amount (capital + interest month 1 + interest month 2 + … + interest month n) will be even greater.
However, it’s not something that should obsess the investor, especially if we’re talking about generating passive income, which means not having to constantly monitor investments.
Investing for a year or more and receiving a comfortable 10% sometimes pays off, as it saves the hassle of repeatedly reinvesting on the platform just to earn a few extra euros. Of course, if you invest 100 euros, we would be talking about cents; if we were talking about millions, we would indeed be talking about many euros. Therefore, the invested amounts also influence whether we seek to achieve a 90% profits with 10% of our time and dedication, or a 100% profits with 60% of our time and dedication. There are no fixed rules, and calculations must be made, taking into account availability to monitor investments.
Returns
It is simply promised or advertised in terms of a promised return. Real returns will vary and will most likely be significantly lower for investors. It is caused primarily by loan repayment schedule deviations and other factors.
The average advertised return of available investment opportunities is calculated by the majority of platforms. It would be unwise to base future expectations on these figures.
Risk should be considered in order to estimate a more accurate return expectation. Few platforms provide both historical loan default probabilities and recovery percentages. These parameters allow us to make more accurate profit estimates. If the default probability is 5%, it is assumed that 5% of the portfolio will default.
When a loan defaults, it goes through a recovery process in which the goal is to recover as much money as possible. The proportion of non-covered loans is known as Loss Given Default. Let us suppose it is 40%. We assume that both parameters have a time frame of one year. Here’s an example:
The promised return is 12%, and the investment amount is 10.000 EUR. Taking LgD (Loss Given Default) and PD (Probability of Default) into account, 300 EUR will be lost in one year (10.000 x LgD x PD). This means that instead of 1.200 EUR, the profit will be 900 EUR (1200 – 300). It allows us to conclude that the risk-adjusted return on investment is 9%, rather than the promised 12 percent.
When it comes to crowdfunding, keep in mind that funds will take time to generate actual profits. When an investment in offered loans or projects is completed, it usually takes some time for the project to reach the required funding amount. There may be instances where this funding amount is not met, and investors receive their funds back with no profit.
Conclusion
Investing in P2P is straightforward to understand, which I believe is fundamental for any investor: it’s crucial for them to comprehend the business.
In P2P lending, the concept is simple: there are individuals/companies borrowing loans and investors lending small portions of those loans among many investors.
Risks are greatly diversified since I prefer to lend 1 euro to 1.000 friends rather than 1.000 euros to one friend. If that friend defaults, I’ll lose all my money. I know that out of the 1.000 friends, some will be delayed by 15%, and even of those, 5% might eventually say they can’t pay me back. But since the other 950 friends will return 11 euros, with the profits from them, I can cover the few who fail to repay.
Therefore, by diversifying across many platforms, within them across various loan originators, and within those by investing in many loans, risks are exponentially reduced.
If you buy a house and invest 200.000 euros, and the construction company goes bankrupt or there’s a fire in the house, you lose 200.000 euros. If I invest in 10 real estate investment companies, and within each, in 100 housing loans worth 200 euros each, when a house burns down or the builder goes bankrupt, my results will hardly be affected at all.
Another aspect is the option to invest in numerous countries, sectors and currencies. Investments are denominated in euros, dollars, or another currency, but for those interested in real estate, it’s beneficial to know the properties they’ve invested in for construction or for exploitation in tourist rentals and eventual sale. For those interested in agriculture, they can invest in helping farmers who want to improve their farming machinery or expand with more land or animals. Some may like companies that purchase portfolios of doubtful payment at a 90% discount to profit after liquidating the assets. Others may want to know about the start-up company they are helping to launch, like a coffe-shop, a new beverage launch, liquor distilleries, etc.
In economics, we also deal with concepts like country risk, currency risk, etc., and thus, investing sometimes in different currencies, sectors, and companies helps reduce the risk that cyclically affects all economies. Therefore, a devaluation of the dollar could be a good investment opportunity for a European, and vice versa, to not only gain interest from the investment but also benefit from the strength of one currency versus another.
As we mentioned, P2P investing is easy to understand and execute, making it an investment anyone can undertake. From a young person with a few euros a month who wants to build a significant savings fund that, with compound interest, will provide substantial amounts over the years, to retirees who sell a property and use the funds to continue enjoying a supplement to their retirement with a 10% annual return on their investment.
If the amount to invest is small, one can start by investing in Mintos, one of the safest platforms in terms of capitalization, loan volume, track record of meeting commitments, and management of its originators. If one wants to diversify or the investment amount is larger, the matter becomes more complex, which is why Carlia Consulting offers consultancy services, including a basic package and two more comprehensive options.
The basic consultancy involves an initial conversation to understand the client’s preferences, preferred sectors, investment amounts, investment timelines, etc., and based on that, designing a portfolio of platforms for investment. We typically recommend the same platforms in which we invest our own money, platforms that have provided us with good real results over the past 4-5 years, not based on advertising opinions or supposed experts who don’t risk their own money. With over 400 platforms in different countries on the market, selecting the best ones is not an easy task (we invest in around 40-50 of them). We show clients our invested amount and platforms selected for our own investments to choose between them for his/her own.
The advanced consultancy, in addition to portfolio design, includes guidance for 1 or 2 months to advise the investor on any questions that arise during that time period, or modifications/corrections after trying out the platforms or expansions in investment after obtaining initial results. It’s a continuous support service.
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