What is P2P investing?

Originally the term P2P investing (peer-to-peer investing) was coined to refer to the form of investing where individuals (peers) lend to other individuals, with the use of a service (aka. a platform) that facilitates the transaction. The borrower would raise a loan of e.g. 1000€ and multiple private lenders could pitch in to the loan.

However, nowadays the term "P2P investing" means so many things. Some people talk about peer lending, some talk about crowdlending or crowdfunding and I'm sure there are even more terms. In this article I'll cover everything you need to know about them if you're interested in the topic.

History and types of P2P investing

Before P2P investing, only companies were issuing consumer credit to individuals. The possibility to finance consumer credit wasn't available to individuals, since a cost-effective mechanism to do that didn't exist. P2P platforms were invented to enable private investors to finance consumer credit directly, without middlemen like banks.

The first P2P platforms was Zopa, founded in 2005 in the UK. A couple of years later Bondora was founded in 2007. Both of these platforms are still around, but they certainly look very different to what they did back then. Also, both platforms offered services to lenders and investors, and did the matchmaking between the two.

The most popular platform nowadays seems to be Mintos in Europe, but that was only founded in 2014. Also the operational model differs significantly from the older platforms. I'll explain in more detail what kind of platforms exist and how they differ from one another.

Loan issuing or loan brokering

Traditional P2P platforms such as Zopa and Bondora issue their own loans. By doing this, they on one hand need to be very effective in credit risk management, but on the other hand, they have less middlemen to share the profits with.

Newer platforms such as Mintos and so many others have drastically different operational models where they buy already issued loans and whole loan books from so called loan originators. These loan originators are the entities that issue the loans, do credit risk assessments and sell on the loan with a small take.

The newer operational model is easier to set up, as you don't need to invest in credit risk assessment yourself. That part is difficult to accomplish without a long history in the field. And even a small difference in your accuracy is important, as it is the biggest competitive advantage you have over other loan originators.

Buyback guarantees or not

A major difference in P2P platforms nowadays is buyback guarantees. I encourage extreme criticism to these promises and look under the hood. I've done the mistake not to.

A buyback guarantee essentially states that the platform (or the loan originator) promises to buy back the loan from you if the borrower misses their payments. E:g. my Mintos portfolio has a long-term internal return rate of 11.02% and all of it has been invested in loans that have a buyback guarantee. Sounds risk-free right? It's not quite that.

There are numerous cases of loan originators going belly-up. If they do, they won't honor the buyback guarantee and the loan brokering platform doesn't have any obligation for it either - so the investor loses. Luckily the loans don't disappear with the loan originator. The borrower still needs to pay back, it's just that recovering the funds will take longer.

There are lots of platforms still that don't offer buyback guarantees, but they're not as popular. One of such is Bondora. These platforms push the credit risk all the way to the investor, which makes for an interesting dynamic. You need to be careful with these platforms, since financial interest may not be fully aligned. On the other hand though, these platforms give the most honest picture of the lending market and as you get to become a micro loan originator yourself, you can better follow the trends of interest and default rates.

I'm following my loan book performance on Bondora since 2016 and my latest update is from early last year. Another update is due soon, so remember to subscribe!

Consumer, real estate or business loans

Accurately speaking, P2P comes from "peer-to-peer", which would suggest that the lender and borrower are both individuals, consumers. Again, Mintos and Bondora are common examples of these, but there are a great many others. Typically these loans go to consumption, covering unexpected costs, loan refinancing or buying a car.

People usually refer to business loan platforms such as Crowdestor and October with 'crowdlending'. A term that I've personally sometimes mixed up with crowdlending is crowdfunding, which people consider to be equity investing, not lending. These loans go to financing a business in the form of a bridge-loan, development project, production or marketing for example - whatever creates business in the future. In business loans the credibility of the platform and the borrower are most important as we have seen fraudulent entities on both levels. So do your due diligence well.

Real estate loans such as mortgages and development project loans are a third category. With real estate loan platforms such as my favorite Estateguru, the LTV (loan-to-value) of the loan and the debt rank are of utmost importance. In the case the borrower cannot pay back the loan, the collateral is liquidated and lenders in order of debt rank will get their investment repaid. An first-rank mortgage on a low LTV project implies a reasonably low credit risk.

Is P2P investing passive investing?

So many blogs including myself refer to P2P investing as "passive income". What is passive income really and does P2P investing generate some?

The answer depends on who you ask and what their definition is, but to be honest, no investing ever really generates passive income. Not even bank deposits, since things change: interest rates can go negative.

With P2P investing, the most common headache is that a loan originator on a consumer credit loan brokering platform goes bust. On Mintos, this is everyday life now and isn't such a big deal for people with distributed portfolios.

For the investor this means that they do need to consider the risks and how active role will they need to take if the risk materializes. In the case of long-term consumer loan brokering platforms, they will take care of everything, but having some funds "in recovery" might feel to you like it wasn't as passive as you thought: you switch it on and it generates revenue without hiccups. That's not realistic with 10% returns.

In fact, if you are truly to become a P2P investor, you need to become good at understanding how loans work, what contracts are made, between whom, what are the obligations of the platform, the loan originator and how can you lose money. And if things go south, what actions can and are you willing to take.

P2P investing risks

One of my most-read articles is an article on peer-to-peer lending risks. To avoid duplicating the content, I'll summarize heavily. If further reading interests you, I recommend checking out the full article.

The nine risks of P2P lending and how to control them:

1. Platform revenue is driven by loan volume: when the platform makes their revenue from loan volumes (e.g. setup fees) it skews them to favor that over loan quality. Make sure you understand how the platform makes their revenue to understand biases.
2. Platform or loan originator shares no credit risk with you: combined with the first point, it might be that the platform or loan originator sells the full loan on, or keeps a portion of it as 'skin in the game'. Skin-in-the-game ensures a certain level of aligned interest to credit risk. Make sure you understand how much skin is in the game and how relevant that is compared to e.g. setup fees.
3. Liquidity risk: what is the duration of the loan and do you have an option to exit early, in case you are in sudden need of cash? Some platforms offer a secondary market where you can sell loans at market value. Other platforms offer buying back loans at the push of a button. Secondary markets are considered financially safer, as an early-exit promise can lead to liquidity problems for the platform if suddenly a large amount of investors try to use it at the same time. We've seen this with e.g. FastInvest last year, where withdrawals started to lag heavily during summer.
4. Can the platform deliver on its promises, e.g. buyback guarantees: someone always carries the risk and you need to understand who that is. Especially when the platform or loan originator promises a buyback guarantee, understand how that is financed. In an economic downturn defaults increase and investors are fearful. If the platform doesn't have a plan for this scenario, what will happen when they cannot deliver on their promise?
5. Bankruptcy and collateral: defaults will happen. In the case of personal loans, the individual might be indebted to you forever. In the case of business loans, there needs to be some collateral for a part of the investment to be recovered. And you need to have energy to pursue this through legal processes. When lending to businesses, go for ones with collateral and where the platform takes care of the liquidation process for you. In case of personal loans without buyback guarantees, be ready for years-long recovery process (this isn't a bad thing at all necessarily).
6. Porftolio risk: How asset-diversified is your portfolio? Do you know the risk-to-return ratios of your different assets? How correlated are your different assets? When done right, P2P lending can lower your risk-to-return ratio at a portfolio level. But you can't have everything in P2P instruments, just the right amount. Read up on my article about modern portfolio theory and how you should consider different investments as tools to optimize the whole portfolio.
7. Cash drag: demand for money isn't static. It fluctuates over time but it also moves around from platform to platform. If you end up in a situation where your money isn't being invested on Peerberry but it's the only platform you're on, how much time and effort does it take for you to open an account on Viventor, if it has more demand right now? Cash drag is especially a thing to be aware of with short-term loan platforms. Platforms such as Swaper and Robocash are brilliant in the sense that they offer as short as 30-day loans with high interests: you get your money back quickly without a secondary market if you need it, but, when demand for money plummets, your idle cash piles up on your account.
8. Political risk: A lot of the P2P industry is not yet properly regulated. High quality players such as Mintos are proactively driving regulation, but there are a lot of those who don't. When regulation eventually will take place, it will uncover the unhealthy operations, causing close-downs and turbulence across the industry. It's inevitable and good, but it will sting.
9. Fraud: a year ago we saw a number of platforms vanish into thin air. There are of course lawsuits ongoing for those, but does that help? I hope so. Nevertheless, it is obvious investors lost a lot of money due to fraud - fraudulent platforms and fraudulent borrowers. Always do your own due diligence and go for long-term, transparent players. Not the newest platform with the hot name and the slick website offering high interest rates. Avoid greed.

P2P investing interest rates

The interest rates vary quite a lot between platforms. My overall portfolio internal return rate is about 8% at the time of writing, which includes significant, complete write offs of four platforms that have gone bust.

October has in my opinion by far the lowest risk, but simultaneously the returns are low, only about 4.1% net of risk, meaning all defaults and other cost of risk already taken into account. However, always consider returns as risk-adjusted returns. In that way 4.1% is not really bad at all.

Sun Exchange has a decent return of 7% adjusted for inflation, considering you're at the same time doing some good for the planet. But level of risk is unclear, so I consider the platform as a form of CO2 compensation with a potential upside. 

The biggest risk platforms I am on are Bondora and Crowdestor. On Bondora, you can invest in ridiculously high-risk consumer loans boasting 270% annual return rate, but what's the chance of one of them actually pulling off paying the loan back? Crowdestor started with 17% annual interest rates, but during corona has dropped to 10%. Time will tell what happens there.

The mid-range of 10-12% is the most typical and most of consumer credit peer lending platforms fall here, including Mintos, Robocash and in the long run likely also Bondora.

Over time though it is certain that risk-adjusted return will not be better than for stocks. Therefore, I don't expect P2P investments to be more profitable than stocks in the long run, but I do expect them to give a very mildly correlating profit to stocks, thus improving my overall portfolio risk-to-return ratio.

A great way to concretize the return rates is to use The Rule of 72, which depicts that the time in years to double the investment is 72 divided by the interest rate percentage. At 7%, the investment doubles in just over 10 years, while at 12% it doubles in 6 years.

An even more convenient way is to use my compound interest calculator, which allows you to try different input parameters and check how your investment could grow over time, given a potential initial investment and monthly additions. Try it below:

But remember, past performance is no guarantee of future.

How to start with P2P investing?

If you want to dip your toes into P2P investing, I cannot give you any investment advice. But if you allow, I'll share my personal favorites of different categories and some reasons for them. You could get familiar with those and see if some of them feel right to you. However, always do your own due diligence and assess the risk yourself.

1. Mintos.com: The consumer loan platform with buyback guarantees and the biggest market share in Europe. Due to their size big blows such as loan originators going bankrupt are just another Friday to them. (my Mintos review)
2. Robo.cash: My favorite short-term loan platform that offers 30-day loans with buyback guarantees and belongs to a super-profitable parent company. (My RoboCash review)
3. Estateguru.co: From all that I've gathered, their real estate operations are superior to any other platform I've seen. I talked to the country manager in Finland and was impressed of the amount of effort they put to managing risk and ensuring a flawless history. (My EstateGuru review)
4. October.eu: For those who see the benefit of diversifying to business loans but prefer peace-of-mind over a high-risk rollercoaster, October is a long-term platform with a great history. Rates aren't too high, but cost-of-risk is the lowest I've seen too. (My October review)
5. TheSunExchange.com: Sun Exchange is my favorite sustainable investment platform that lets private investors buy solar cells in mainly South Africa. They get green electricity, the investors get dividends from the sold electricity. (My Sun Exchange review)
6. Crowdestor.com: A polar opposite to October, Crowdestor is the high-risk, high-return business lending platform. I especially appreciate the proactive way they handled the year 2020 from both investors' and borrowers' points of view. (My Crowdestor review)
7. Bondora.com: A lot of my readers dislike this platform, but Bondora is the most transparent lens into the consumer lending market. It's ruthless and the eventual rate of return will be fractions of what the early days indicate. The secondary market also means heavy discounts. But, all the other platforms hide the mechanisms with efforts for steady rates and buyback guarantees. Bondora is a long-term commitment. (My Bondora review)
8. Bonus: Nexo.io. If I were to lend against crypto currencies, I'd do it on Nexo. They have an interesting concept, where the crypto currency is held as collateral against the loan. (Nexo review)

That's a good coverage of platforms and I've picked my favorites to represent very different categories, so if you are new to P2P lending, getting to know how the above ones work will give you a good idea of what's out there.

Most of these platforms follow a very similar logic to getting started:

1. You register for an account
2. Go through the "Know Your Customer" process by providing documents of your identity
3. Transfer money to the account
4. Invest by hand or by an auto-invest function

Check out my review links for more detailed information.