4-Step Strategy to Safe Peer-to-Peer Lending

Safe peer-to-peer lending is not as risky as the stock market. Not by a long shot.

On average!

However, as with the stock market, the risks in P2P lending are not uniform. Some lenders will lose a lot of money over the next half century, simply because they don't have a plan or do no research.

That said, the risks in P2P can be reduced to a very low level with a simple, sensible strategy.

At the same time, the probable returns increase with a sensible plan, because lenders who focus on containing the risks get better results in the long run.

1. Spread your money across 100s or 1,000s of loans

You wouldn't buy just one share on the stock market with all your savings. (We hope!)

Lending all your money to one borrower is also a highly risky thing to do. Imagine if a bank manager did that? She'd get fired from head office right away.

To give ballpark figures based on 4thWay analysis, say you lend all your money to just one ordinary individual borrower just before a recession hits. You have maybe a 10% chance of losing three-quarters of all your money. But lend to 100 people and the chance of losing most of your money falls to less than 0.0000001%.

You should aim to spread all the money you put into P2P across hundreds or thousands of borrowers.

Many P2P lending companies make this easy by automating your lending. Some split your money between lots of borrowers without any action from you.

2. Commit to re-lending and then exiting “naturally” through borrower repayments

The stock market is so rocky that you can't even be confident of coming out well over 10 years. That's why it's a very long-term investment.

Peer-to-peer lending, like bank lending, is lower risk, because it's easier to predict what might go wrong with a basket of borrowers in a recession, and set interest rates accordingly.

4thWay's bank modelling shows huge resilience, with both 4thWay's models and the P2P market having been seriously tested several times.

This resilience is especially strong if you commit to a minimum period of time. So we're confident that regular lending and re-lending of repayments and interest will see the vast majority of people come out fine.

This has already also been demonstrated since 2005 – through two recessions and a property crash. Almost all lenders with sensible strategies have made money every year, but certainly well within five years they have done so.

4thWay's specialists recommend you lend and re-lend your repayments and interest for at least two years.

When it comes to exiting your loans, be prepared to wait until borrowers repay naturally, with interest. That's the normal investing period when doing money lending.

If you aren't prepared to do that, you might have to try to sell your loans early at a time when this is difficult. In some cases, you might be able to exit early, but only by selling your loans to other lenders for a cut price.

3. Spread your money between six or more P2P lending providers

We've found that a minority of long-term 4thWay users lend through just one or two lending accounts, when you should be using six or more different providers if you want to properly minimise the risks to a very low level.

Six is the absolute minimum, which you can use if you are just lending through providers that offer property lending to high quality borrowers who rarely fall late on their repayments. If you lend through accounts where a lot of borrowers fall late – even if that money is usually recovered in full – you should be aiming for several more lending accounts to reduce the amount in a single provider.

The vast majority of us should stick to the P2P lending companies that take multiple steps to protect your money. Go for super-prime borrowers. Lend your money against property that is valued much, much higher than the loan that is taken out.

Providers often have other defences which contribute to earning 4thWay PLUS Ratings. These things, which are weighed mathematically using international banking standards when our specialists calculate their ratings, include:

• The type of lending.
• The results of each historical loan.
• The interest rates.
• Whether pots of money are set aside to pay expected bad debts.
• The P2P lending company or its directors promise to take the first loss on all loans.
• Partner companies agree to buy back bad debts.
• The quality of any security offered by borrowers to back up loans, such as their properties.
• The length and breadth of the provider's history.
• And many other items.

The 4thWay PLUS Ratings just measure the reward (interest earned) against the risk of losses from bad debts, i.e. borrowers becoming unable or unwilling to pay when their legally-correct contract requires it of them. There are other risks that you need to assess separately.

4. Keep an eye on rising risks

By following the above three points, you can expect to come out with satisfactory rewards – even if you were to suffer extra bad debts due to a recession similar to 2008.

However, while the P2P lending companies you use today might have extraordinarily good borrowers and defences against losses, that won't always be the case for all of them. For some of them, cracks will start to show or their standards will slip.

This has already happened. A couple of P2P lending companies lost their 4thWay PLUS Ratings or “buy-tip” status from 4thWay's specialists, which gave our users plenty of time to get out. Over a year later, these companies went under in complete and total disgrace.

Many, many other providers failed to be rated or get buy-tip status in the first place, as their apparent good work was plastering over a lot of weaknesses.

So watch very closely for warning signs that their standards are slipping and get out when you no longer recognise it as the safe company you first lent your money through.

These warning signs can include such things as late payments rising much faster than other P2P lending websites, many more loan applications being accepted, bad-debt provision funds shrinking fast, or interest rates getting lower and lower.

Not all the best P2P lending companies will retain their great 4thWay PLUS Ratings forever and subscribers to our email will be first to know when any of them are slipping.

This was part five of our ten-page P2P lending guide

Read part four: The 13 Key Peer-To-Peer Lending Risks.

Read part six: 10 Ways To Get Your P2P Lending Money Back!

See the contents of the whole 10-part guide.