Greed and Fear in P2P Lending

P2P lending is an investment and all investments go through cycles. It doesn't matter what you invest in, be it shares, property or something else, all of them are driven up and down by supply-and-demand, greed and fear.

It's the last two that cause huge bubbles and big crashes. Investing in P2P loans is not likely to be different.

The best time to lend and invest

The best time to be investing is when everyone else is panicking around you. This is when there are fewer people willing to invest – or lend – money. With less competition to lend, it means you can offer to lend at higher rates even to high-quality borrowers and they'll probably have to accept them.

And lenders will sell out of their existing loans to you at bargain prices. That's right, if you don't know, many P2P lending websites let you buy and sell loan parts and the price isn't fixed. Someone in an extreme fit of panic to get out might sell £500 of loans to you, but you could demand they accept just £350. If he was earning 10% interest, you'll effectively get 14%. In five years you could almost double your money, rather than make just 60%.

It is during these times that a relatively small group of individual lenders will make a great deal of money, and P2P lending, on some riskier P2P websites at least, will look more like the stock market than a steady income stream from borrowers.

The equivalent in the stock market is when large numbers panic off the back of hysterical “expert” commentary and hype in the press.

The irony is, when share prices are lower, the risks of buying are also lower. It's obvious really: if you're told you could buy shares in Apple today for either $120 or $110, you know which you'd pick.

The trick is to keep your head and think long term when everyone else is losing theirs.

We're in a good period for P2P lending

No one is panicking about P2P lending right now, but on the whole people are still cautious. When people are investing cautiously, they demand more reasonable returns for the risks they're taking.

As we showed in our news article about Funding Circle yesterday entitled Funding Circle A+ Loans Are High Interest For Low Risk, P2P lending companies appear, at least from the superficial assessment we did there, to be providing good returns on average for the risks we're taking, at least at the lower-risk end. This certainly matches the internet buzz and all the polls.

When to worry most

So the best time to lend is when everyone is frightened. The worst time is when everyone thinks nothing can go wrong. The P2P lending industry, in the UK at least, has started on the right foot. The large companies in the business are desperate to be safe and transparent.

As more people come to trust this, more money will pile in. This pushes down interest rates since more people are competing to lend. This is rather like higher stock prices: the risks to you now are higher, since you have a smaller safety net in interest.

This situation is also likely to cause some of the P2P lending websites to loosen their lending standards in order to try to attract more borrowers, so that lenders can keep lending at higher rates. We've seen identical behaviour many times in every other investment asset class under the sun.

It's like the height of the 2007 property bubble when a decade of strong rises had “proven” to people that this time is different, just before they finally collapsed. Even the lenders had come to believe that they'd been taking large, 25% deposits for no reason, so they started offering mortgages with no deposits. But it was the 25% deposits that had made mortgage lending safe from the 30s to the 80s.

So when everyone says P2P lending is completely safe, be afraid. Keep an eye on your interest rates and demand a decent return. And watch out for P2P lending companies who are inching up their borrower acceptance rates. 4thWay^® keeps track of those figures in our comparison tables, whenever we can get them.

Keeping your head

Experienced investors know to be wary of the phrase “this time it's different”. There is no reason to believe that P2P lending will escape bubbles and crashes, but that doesn't mean you can't steer clear of trouble, just as other patient, calm investors do elsewhere. The rules for investors are simple, but, as experience in other investment shows, not always easy to follow:

• Always demand interest rates sufficient for your risks; do not chase interest rates too low based on widespread, copycat “expert” media commentary.
• Spread your money across a great many loans.
• Lend regularly so that you don't just lend everything right before a recession. The discipline of lending regularly also helps you to plod through times when even you, patient investor, might be wondering whether all the headless chickens are right.
• Finally, if low risk is key, you could lend most of your money through lower-risk P2P websites and to lower-risk borrowers.

We firmly intend to keep our heads while other researchers are panicking. Stay informed by us by signing up to our newsletter using the form above right.

*Commission, fees and impartial research: our service is free to you. 4thWay shows dozens of P2P lending accounts in our accurate comparison tables and we add new ones as they make it through our listing process. We receive compensation from Funding Circle, and other P2P lending companies not mentioned above either when you click through from our website and open accounts with them, or to cover the costs of conducting our calculated stress tests and ratings assessments. We vigorously ensure that this doesn't affect our editorial independence. Read How we earn money fairly with your help.