Should you be investing your money on Peer to Peer (P2P) Lending Platforms?
Peer-to-Peer(P2P) Lending is lending money among individuals without the help of a financial institution; It’s also known as social lending or crowdlending. Though it is an age-old practice to borrow from family and friends at the time of need, P2P lending formalizes this practice between lenders and borrowers, who are unknown to each other.
P2P Lending is a new-age avatar of old-fashioned borrowing retouched by the principles of crowd lending and technology.
It is a non-institutional platform for people to lend money to individuals who are looking to borrow money without providing any collateral. The interest paid by the borrower is paid to the lender, with or without deduction of charges by the lending platform.
How does P2P lending work?
P2P Lending works on the concept of crowdlending. Let’s assume you have excess funds and don’t mind extending a loan to another individual in exchange for higher returns.
At the same time, there might be an individual somewhere in the country who is in need of money either to fund his business or buy a car or sponsor her child’s education. Sometimes, it becomes a major hassle to procure a loan through banks or NBFCs, especially if your loan requirement is small or if your credit score is low.
P2P lending platforms match this lender-borrower requirement so that a borrower gets money for his needs and the lender gets more out of his money.
A lender can spread his funds to many borrowers with different risk profiles and a borrower can raise his loan through part-funding from many lenders.
This type of lend-borrow model can be compared to the likes of online shopping platforms, which eliminates the need for distributors, who sell the products of a company to the consumer. Here, a borrower can obtain a loan directly from the lender with less hassle of paperwork, processing fees and for lower amounts.
However, though the returns from P2P lending are predicted to be higher than FDs and mutual funds, it comes at a greater risk for the lender.
Are the P2P lending platforms regulated?
Yes. Reserve Bank of India (RBI) recognized P2P lending platforms as NBFCs and published the guidelines to regulate the lending marketplace. The directions issued by RBI, under the NBFC-P2P Lending Platform has defined the norms and scope of activities of such platforms.
Here are some of the important regulatory aspects you should know about P2P Lending Platforms:
- It should only act as an intermediary that provides a marketplace for lenders and borrowers. P2P platforms cannot either lend their capital or borrow from other registered lenders.
- It cannot raise deposits from anyone.
- It should not cross-sell products except loan-specific insurance products.
- It should conduct due diligence on all participants – both lenders and borrowers.
- It should assess the creditworthiness and conduct risk profiling of a borrower and disclose it to the lender.
- It should undertake documentation for loan agreements and other related documents if required.
- It should assist loan disbursal and repayment of the loan. There should be no direct transfer of loan amount to the borrower from the lender or direct payment of EMIs to the lender by the borrower. All the financial transactions have to happen through funds transfer from Escrow account mechanism only.
- It should provide recovery services for loans originating from the platform.
Also, RBI has laid down norms for lenders on the P2P platforms.
- The aggregate exposure of a lender across all P2P platforms and all borrowers at a given point in time, should not cross Rs.10Llakhs.
- A single lender should not have an exposure of more than Rs.50000 to the same borrower at a given point in time, across all P2P platforms.
- The term of the loan should not exceed 36 months.
Also read: Prepay EMI or Start a SIP?
How can you start lending on a P2P platform?
There are many P2P lending platforms in India. You can register yourself as a borrower in any such platforms. You will be required to fulfil the KYC norms as per RBI guidelines.
You may have to pay a flat fee as a lender, to register on the platform.
You will be given the information about the loan amount required and the risk profile of a potential borrower. You can get to know about the potential borrower’s credit score, his justification for requesting a loan and some platforms do allow direct interaction between a borrower and lender also.
Just like MFs and direct equity investments, To increase your rate of return, you can spread your investible amount across loans of different risk profiles.
It is the duty of the platform to collect the monthly EMIs, which includes the principle and interest, from the borrowers in an Escrow account. The EMI thus collected from a borrower is divided according to the ratio of the loan funded by the lender, and is credited to the lender’s account.
If you have funded multiple loans, you will receive a monthly payment from the lending platform, after receiving EMIs from all the loans you have funded.
You can choose to reinvest your earnings or withdraw the funds as you wish to.
Pros and Cons of P2P lending for an investor
For an investor, P2P lending gives a new opportunity to diversify his investments. It may give a better return as compared to fixed deposits and may potentially be better the returns from mutual funds and equities, over a short term.
Unlike investments like real estate and equity, the returns from P2P lending is less volatile and is usually known to the investor beforehand. Since the loan term is capped at 36 months, the returns over the short term are quite high when compared to similar investment products in the market.
Also, the cash flow is not tied to maturity and the lender will start receiving the returns within a month from starting the investment. You can start investing in this platform with an amount as low as Rs.10000.
The major disadvantage for investors in P2P lending is the risk of default by the borrower. As a lender on the P2P platform, you have to bear the entire risk of default by the borrower. The platform may not even bear the legal expenses if a borrower defaults.
Pros and Cons of P2P lending for a borrower
For borrowers with low credit score, P2P lending platforms are a boon. These platforms can provide loans without collateral to those in need of funds. Also, a borrower can borrow as low as Rs.5000 on these platforms. It is ideal for those who want to avoid excess paperwork, have allowed credit score or are unable to raise funds through the formal banking system.
The disadvantage for the borrower is that they may or may not be able to raise the amount they require. They might not be able to find a suitable lender or the required amount may not be matched through crowdfunding also. Also, the interest rate on loan based on the risk profiling of the borrower narrows the difference between borrowing from banks and P2P platforms. A borrower might have to pay higher interest rate than charged by banks if he takes a loan from P2P platforms.
Should you invest in P2P Lending?
P2P Lending Platform is no-doubt an innovative investment option. However, it comes with a huge risk. You might lose the entire investment amount if a borrower defaults and you may have to bear the legal expenses to recover the same.
Not to forget that the RBI regulations mandating the creditworthiness and risk profiling of the borrowers reduce your chances of losing the invested capital. Also, most platforms have lender protection policies in place to safeguard the interests of the investors.
You can consider investing in P2P platforms for better returns from your overall portfolio subject to the following.
a) You have a well-diversified portfolio.
b) You are looking for regular/monthly income.
c) You are investing not more than 10% of your investment portfolio.