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Peer to Peer Lending: The Investment You Might Be Missing Out On

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If you haven't heard of Peer to Peer Lending you are missing out on what is turning to be a very hot investing opportunity.

In the current economic climate, person-to-person (P2P) lending has become rather popular. It provides alternatives for both borrowers and investors who are looking for ways to meet their financial goals.

What is P2P Lending?

These services provide a way for ordinary people to loan money to other regular folks. In most cases, it's done through an intermediary. Two of the main P2P lending web sites are Lending Club and Prosper.

These sites facilitate the loans, which are funded in small increments of $25. Because each note is only $25, nearly anyone can afford to be a lender. And, because the amounts are small, borrowers can take advantage of thousands of potential lenders and raise money they might not otherwise qualify for.

P2P lending web sites coordinate everything, from determining what rate the borrower receives (and the return the lender can expect to receive) to providing the funds to the borrower and collecting payment on the loan to making sure each investor receives principal plus interest from the payments.

P2P Lending for Borrowers

In many cases, borrowers can receive a lower interest rate on a P2P loan than they would receive from a bank. Additionally, it's often possible to get approved for a larger unsecured loan than many banks would be willing to approve.

However, it's not a free-for-all. Borrowers do have to agree to a credit check, which determines the interest rate of the loan. There are cases in which a potential borrower might be denied. Prosper, especially, is known for screening out borrowers with low credit ratings.

Once a borrower has gone through the process of approval, it's time to try to raise the funds. P2P lending is usually an all-or-nothing proposition for borrowers. If they don't reach the target, they receive no funds at all. This means that borrowers have to attract lenders. This can be done by explaining the purpose of the loan, answering questions that potential lenders can leave on the account, and proving that the resources are available for repayment.

P2P lending usually allows borrowers to choose between three year and five year repayment. Prosper has a limit of $25,000, while Lending Club has a limit of $35,000. It's important to realize that this is a loan that is reported to credit agencies. If you miss payments or default, your credit score will reflect your delinquency.

P2P Lending for Investors

Many investors have found a measure of success through P2P lending. While stock market returns are rising, the years immediately following the financial crisis saw lackluster returns, which were, in some cases, beat by the returns from P2P lending. Even the lowest returns on P2P lending handily beat the "safest" bonds.

When investing, though, it's important to remember that you are lending money. This means that you can lose some or all of your investment if a borrower defaults. However, with some planning, it's possible to invest in a variety of notes across risk levels and build a reasonable portfolio for a relatively low cost.

Since P2P lenders charge fees to borrowers, and earn their money from the loans they originate, there aren't fees charged to investors. The only exception is for investors who decide to take advantage of some of the managed options provided in some cases. As long as you select your own notes, though, you won't be subject to costs.

I've had good success with investing with Lending Club, and I recently began investing with Prosper.

In fact, I recently did an experiment of Lending Club vs. Prosper comparing the two for over the past year. The results have been impressive both netting me double digit returns.

Just like any investment, research and acknowledgement of risk is required.

Bottom Line

P2P lending offers alternatives outside of the "traditional" opportunities that many borrowers and investors see. Evaluate your situation, and determine whether or not P2P lending is right for you -- whether you want to borrow, or find a new place to invest.