It’s been almost a year since I started participating in several Peer to Peer / Crowd Lending platforms (I will refer to these as the platforms). This was my first introduction to the “making your money work for you” principal. Let’s start with the basics…
What is it?
What are these platforms? Well, as far as I know them, they are companies who gather a community of small-scale investors that can invest larger amounts together. They provide loans to individuals, startups or settled businesses.
So, how does this crowd lending for you as an investor work?
- Register on a crowd lending platform;
- Search through their projects;
- Find a project that matches the risk (more on the risks later) you want to take and the return on investment that you are looking for;
- Sign into that project with an amount you want to invest;
- Wait for the platform to find other investors until enough money is found to fulfill the project’s request;
- Transfer your investment to the platform once it requests you to do so;
- Wait for the platform to send the total amount to the project. The project will then start;
- Collect your money as the platform will collect the repayment and interest from the project, and distribute that to the investors.
What are the risks?
You are lending out your money to “people with great ideas”, and occasionally these projects fail, resulting in a default. Depending on how far the project was with repaying their debt, you might lose a lot of money because the platforms will not refund any of this!
Default: noun, failure to fulfill an obligation, especially to repay a loan or appear in a law court.
The first of those in this case. The project is obligated to repay the loan, but for whatever reason they don’t have that chance. The crowd lending platform will then take legal actions in order to get as much of your money back as possible, but unfortunately they are not always able to do so.
Pro tip: Take the time to investigate a project before you decide to invest in it. Read through their financial statements, read through their business plan. Only if you have a good feeling about it, invest! Otherwise, just wait – there will always be another project and you shouldn’t invest in something that you don’t believe in.
Because of the chance of a default, I decided for myself that I would use a small amount of money every month that I did not need. Besides that, I would spread my investments as much as possible. For example, if the smallest allowed investment on such a platform is $25 and I was planning to invest $100, then I would not invest more than $25 in one project.
Investing too much money
Most of the investment platforms have a kind of quiz that you have to take, in order to prove that you know how to spend your money wisely. They will question you on how much of your savings you are planning to spend on crowd lending and here I agree on their expectations:
Never invest more than 10% of your savings in crowd lending and never invest money that you can’t afford to lose!
Now I know we’re investing to earn money, but even with a 1-2% risk on A rated projects that’s money you can lose – it will be gone! Now all of this is not to scare you off, in fact I highly encourage you to participate in crowd lending, but you should really be aware of the risks.
There are multiple lending platforms out there, and also better comparison sites than my blog over here, but personally I’ve had great experiences with Funding Circle (international) and Geldvoorelkaar (a Dutch platform). I’m not eligible for Lending Club because I’m not a U.S. resident, but I’ve also read good stories about that platform.
Usually you can check out the projects without registering for an account, so make sure you take a good look around before you start investing.
If you’re particularly interested in the development of Peer to Peer Finance and Crowd Lending, check out this E-Book on The Future of P2P Finance.
Note: to read E-Books you need an application. Kindle is a free online E-Reader!
Let’s wrap up with an example about the…
Awesome Shoe Factory
The “Awesome Shoe Factory” is looking for a loan to expand their current shoe production. This will cost them $50.000 in total, which they don’t have at the moment. They have made a plan and believe that the loan will earn itself back and more. But where will they get the money they need? After some looking around, they settle with a Crowd Lending Platform which looks into their request and judges their plan and financial information. Based on this, the platform assigns them a risk category (usually a letter between A and F, where A stands for highly reliable and F stands for a big risk). Based on this risk, the platform then assigns them an interest rate (usually ranging from 4% to 25%) where the higher interest rates correspond to the risky projects. Since, in our example, the shoe factory has had very reliable financial gains in the last several years, the platform assigns them a relatively low risk category “B” which corresponds with a 6% interest rate. The platform then publishes the project on their website, stating the following information:
- The Awesome Shoe Factory
- Project description, including expansion of the production
- Loan: $50.000
- Risk: B
- Interest: 6%
- Minimum investment: $100
Investors can then invest anywhere upward from $100, until the goal is met. The platform will then collect the money from the investors and set up a contract with the Awesome Shoe Factory. They will provide the shoe factory with their loan and collect monthly repayment and interest which will be distributed to the investors (after the platform takes their fee, of course!). The fee is usually 0,5%-2% of the interest rate, you should take note of this because it actually lowers your expected income.
Profit and experience so far
Read about my first results in my next blog post.
What are your thoughts on crowd lending? Are you investing in other individuals or companies? Have you got questions or tips for others? Share it with us in the comments!