Two years ago I started a pair of experiments which explored peer-to-peer loans. A peer-to-peer loan is a situation in which people are borrowing money from other individuals rather than from a central institution such as a bank or credit union. Typically, a peer-to-peer loan involves a relatively small amount of money, a few hundred to a few thousand dollars, and is paid back in a few weeks to a few years, depending on the needs of the people involved.
I called my journey into peer-to-peer lending giving money to strangers on the Internet and talked about the experience of using two peer-to-peer platforms. I first began exploring the peer-to-peer market in an unregulated forum on Reddit where virtually anyone can request loans and anyone who wishes to lend money can respond with an offer to help. This is sort of the Wild West approach to peer-to-peer loans where there is virtually no regulation, tracking, or safety net.
A few months later I began using a regulated marketplace for peer-to-peer loans called goPeer. A peer-to-peer marketplace acts a little like a stock market for loans where one person requests a loan for a certain amount of money. Then lenders (sometimes called investors) can each offer to lend a percentage of the total loan. This means, for example, one person can request a loan of $5,000 and 500 different people can each supply $10.
The idea behind the marketplace approach is that it helps borrowers get larger loans by allowing them to receive money from multiple lenders. It also helps the investors spread out their risk by only contributing small amounts into each loan.
Common questions and concerns
One of the biggest concerns I encounter when discussing peer-to-peer loans, either in person or on-line, is the idea that random strangers on the Internet are just going to take the money and run. Why would they pay back a loan when they are almost entirely anonymous and there is almost no side-effect to taking the money and disappearing?
On a social level, I think a lot of people want to be productive, honest members of society. At least to the extent they can be. Most people seem to have a sense of honour or duty or a self-image that motivates them to pay back their loans. Also, not paying back a loan will usually mean getting blocked on the lending platform they are using, which cuts off access to future funds. In the short-term taking money and running might seem beneficial today, but it is cutting off an avenue for getting another loan in the future, and you never know when you might need money again.
When taking out a peer-to-peer loan through a more formal marketplace, such as goPeer, defaulting on a loan can also have negative side-effects. The money for the loan is provided by a group of individuals, but it is collected by the goPeer institution. Which means someone defaulting on a loan will result in collection calls, a decrease in credit rating, and maybe court proceedings. Most people don’t want to experience that process.
Another concern I hear a lot is the worry that people who ask to borrow a peer-to-peer loan must have bad credit and, even if they wish to pay back their loans, the borrower might be unable to do follow through. In some cases this might be true, some people may be turning to peer-to-peer loans out of desperation. However, I think this is a narrow and possibly outdated viewpoint.
In the past, banks were often seen as upright institutions and cornerstones of the community. If you wanted a loan or a mortgage or anything else involving money, the conventional wisdom was to go to a bank. You could walk in or make an appointment quickly, talk to a banker who was a member of the community who knew you, and form an ongoing relationship built on trust. But that was before banks made profits measured in the billions of dollars, before small town branches were closed in a lot of areas, before making an appointment required multiple steps on-line and it could take weeks to get in to see someone. It was prior to outlandish banking fees and it was before banks triggered the housing crises of 2007-2008 and crashed the economy.
My point is that a lot of people don’t trust banks these days and, even if they do, a lot of people are more wary of debt. Even if people trust banks entirely and are not worried about being in debt, they are aware doing business with their bank is likely to involve a lot of time and paperwork. If I want to see a banker about a loan it is a ten minute process to set up an appointment on-line and no one is available for two weeks to see me. Then I’ll need to fill out some paperwork and it might be another few days or a week before I get a response – putting my line of credit or loan into place.
On the flip side, if someone posts looking for a peer-to-peer loan on a forum, they may have a response in minutes. For people with good reputations they could have their loan within a few hours. People I’ve loaned money to (and had them pay me back successfully) multiple times might text me for a loan and receive the money in their account in under an hour. Banks simply can’t provide that level of service.
Convenience aside, some people can’t get a loan from a bank because they have no credit. Not bad credit, just no credit history. Someone who pays all their bills and has avoided debt their entire life might be very good with money, but not have a credit score to reflect this because they have not needed to borrow money from a bank. These people might turn to peer-to-peer loans because they’ve been good with money and, as a result, the bank doesn’t see a credit history they can use as a basis of trust.
The proof
All of the above is more theory than fact. I’m putting forward my views on why I think people will use peer-to-peer lending platforms and why they will pay back their loans. But are my ideas reflected in real-world experiences?
So far, on Reddit (the Wild West of peer-to-peer loans), I’ve engaged in 130 loans. Of those, 110 were paid back successfully in full. That’s an 85% success rate. On the other side, 20 of the 130 failed to pay me back entirely. Of those 20 failures, in only 7 was I unable to get any of my money back. In the other 13 cases I was able to get back some or all of the principal loaned eventually.
This success rate has resulted in a profit of $2,500 (after all the defaults, transfer fees, and dollar exchange rate fees) over a period of 24 months. I started out loaning a total of $2,000 and not only earned that back, but made $2,500 in interest over two years. This works out to $104 per month in profit, after all the fees and losses. Which, I think, backs up my theory that people mostly wish to pay back their loans and can do so successfully.
How have the more structured, automated loans through the goPeer marketplace performed? The experience has been more conservative (loans for smaller amounts, spread over more people) but the results have been similarly positive. I’ve engaged in 647 loans to date through goPeer. Of those, 6 have defaulted. That’s approximately 1%, with the other 99% repaid (or in the process of repaying). This has resulted in a profit, after all the defaults and fees, of $1,100 over the span of 20 months. In other words, about $55 per month, and it has been fairly consist.
In total, my experience has been a mostly steady inflow of approximately $149/month since I started this experiment. It’s not a lot, but it is (once I was up and running) almost entirely passive income. These loans won’t make me rich, it won’t give me enough to live on, but it is approximately enough to pay my Internet and phone bill each month.
Peer-to-peer loans in the bigger picture of investing
In general, over the past 20 months with goPeer I’ve averaged around a 6% profit. Sometimes people look at this and question why someone would invest in a platform that is returning in the range of 5% to 10% interest for most investors when there are other investing opportunities which can return more. It’s a fair question and one which I can mostly answer with: diversifying.
I am of the opinion that a healthy financial portfolio is one with some diversity. I think it makes sense to place funds in a wide range of areas in order to both gain some profit and to also avoid a failure in any one area causing complete ruin. It’s very safe to put all of one’s money into a GIC, but it is not really profitable, the account will probably just keep up with inflation. On the other hand, the stock market can offer much better returns on investment on good years, but sometimes the stock market drops suddenly and that can be painful for people who are heavily invested in stocks.
Peer-to-peer lending offers one way to provide some slow and steady profit, slightly above the rate of a GIC and slightly below the average of the stock market, but with (in my experience) a more stable flow than the stock market. It’s a middle ground and a way to diversify, avoid keeping all of one’s eggs in the same basket.
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