3 Key Things When Choosing P2P Lending Sites

With the growth of peer-to-peer lending websites there are a few things that we individual lenders need to be sure of before we invest our hard earned money.

1. How P2P lending websites assess borrowers

Critical to achieving a decent return is understanding the true risk of the potential borrower and the interest charged: are they commensurate with the risk?

All P2P lending websites undertake the risk assessment on our behalf. That’s what you usually pay them for. But how good are their ratings?

If it’s new, it is likely that they will have little data to build precise models with and so they will rely heavily on a credit bureau scores.

In small business finance there are many providers of credit bureau scores, with varying degrees of quality. Some say a business is a good risk while others say it won’t lend it a bean.

The personal loans space is dominated by only three credit bureaux in the UK and thankfully their scores are fairly similar in terms of risk prediction – and they are pretty good too.

2. Lots of experience required

In tandem with this point is the quality of the P2P lending website’s risk management. How experienced are they? Do they know what they are doing?

One would like to think they do but some new start-ups in this space probably have less experienced people than the larger, older P2P lending websites.

This is even more of a concern if they automatically lend your money. (I like to pick my own borrowers.)

3. Interest rates must compensate for risks

Another thing to be wary of is the interest rate offered, especially against any potential stress in the economy. Business insolvencies, in most downturns, rise quite dramatically.

Banks don't normally just concern themselves with the losses they expect in current economic conditions. They also consider the losses that might occur in a severe downturn. (This calculation is taken care of by the Basel 3 rules if you are interested.)

Do you ever think about this? Certainly the P2P lending websites only tend to concentrate on recent historic losses almost always generated from the last recession of 2008.

So a P2P lending website that has been through a recession is well placed to understand how steep losses can get.

But not all downturns are the same. The last one, for example, had remarkably low interest rates which helped with affordability.

More aspects to consider

Other aspects to consider are the size of the marketplace the platform can attract and the incidence of early settlement. If a loan you invest in repays early and a new home cannot be found for your money, then your returns will be lowered, possibly significantly.

Read more: 4-Step Strategy to Safe Peer-to-Peer Lending.