Are you tempted by the 20% expected returns provided by some p2p loans? But do you know that there are already a few defaults and several other problem p2p loans in the industry? p2p lending can give good returns, but the risk is also higher. How should novice investors approach p2p lending? Here are the quick tips.
Invest only an amount you can afford to lose
p2p lending is a very new in Singapore and there are plenty of risks. The p2p platforms are startups, underwriting standards have not stabilized and transparency is inconsistent across platforms. MAS may introduce regulations soon. If these risks are too much for you to bear, please stay away from p2p lending. However, if are an early adopter, start small with an amount you can afford to lose. When I started last year, my initial capital for p2p lending was $2,000. As I get more comfortable with p2p lending, I increased my portfolio size accordingly. The idea is to start small and slowly ramp up.
Use the platforms that suit your needs best
Every platform has their own strengths and weakness. Do your research and find the platforms that best suit your needs. Do you like to examine a borrower’s financials statements in details, or do you just take a cursory look at some financial ratios? Do you prefer to diversify across many small loans, or concentrate your lending on several bigger loans? Other considerations include: types of loans, underwriting record and level of transparency. For example, MoolahSense generates good loan volume but does not disclose detailed financial information on the borrowers. The minimum investment is $1,000 per loan. On the other hand, Funding Societies has lower loan volume, but gives loansheets with detailed financial information, including qualitative risk assessments. Its minimum investment is also lower at $100 per loan.
Watch out for platform risks
p2p platforms are startups and could also fail. Investors could lose their money held at the platform. One way to reduce such risk is to use a platform with a third party escrow agent. Another way is to reduce the idle money on the platform’s account. Transfer them back to your bank account. Lenders can also politely ask the platforms to show proofs that they have sufficient money to run for another 1-2 years.
Know how the expected returns are calculated
There are different types of interest rates: gross, net, effective and simple. Lenders should focus on net interest rates – which means the returns after deducting all fees. Effective interest rates account for compounding, while simple interest rates do not. When comparing interest rates across platforms, make sure you are comparing apples to apples. Personally, I prefer to use net effective interest rates because most platforms report this figure. For more detailed explanation on this topic, see here.
Don’t be tempted by high interest rates
High interest rates usually goes with high risk. It is better to go with a moderate interest rate loan with moderate risk, rather than a high interest rate loan with high risk. Credit analysis is an extensive topic, but to get a quick idea on the risk of borrower, you can look at the borrower’s credit rating, type of business, years in operations, historical profitability and cashflows. MoolahSense, Funding Societies and CoAssets do unsecured lending, Capital Match, New Union and InvoiceInterchange do asset-backed financing. Take your pick.
If you are interested to test your ability to pick p2p loans, there’s also a fun, educational contest conducted by New Union now. It is like paper trading for p2p lenders. Investors get the chance to improve their credit analysis skills and a chance to win $10,000 New Union credits. https://www.newunion.sg/lendorfend
Don’t put all your eggs in one basket. In the lending business, defaults are inevitable. By diversifying across many loans, one or two defaults won’t impact your portfolio too severely. My p2p portfolio consists loans from different platforms, different borrowers. The loan amount also differs – I tend to lend larger amounts ($1,000 to $3,000) for less risky loans and smaller amounts ($100 – $500) for loans that are riskier but provide attractive interest rates.