How Safe Is It To Invest Money In P2P Lending? What If A Borrower Defaults?

12/01/2024 | 4 Comments

In the last couple of years, peer-to-peer (P2P) lending has become quite a popular alternative investment option for millions of people. Moreover, with the advent of the internet, the availability of online P2P lending platforms has allowed investors to lend their money and borrowers to avail loans easily. P2P lending allows individuals to lend money directly to borrowers without any sort of involvement of traditional banks and institutions.

Though it cannot be defined that it offers good returns and is definitely convenient, you must be aware of the P2P lending risk. So, let’s move ahead and understand how safe it is to invest in P2P lending, significant ways to avoid the risk in P2P and what happens if a borrower defaults.

How Safe Is Investing in P2P Lending?

Without any doubt, P2P lending can be rewarding as it offers great returns, but, as mentioned earlier, you should also understand that it is not without risks. Understanding the risk in P2P is important for you so that you do not fall prey to defaults or lose money in any form. So, here are some significant P2P risks you must be aware of:

Credit Risk

A primary risk in P2P lending is the credit risk and this refers to the likelihood that a borrower may default on their loan, which means they can fail to repay the borrowed amount. Unlike banks, P2P platforms may not have the same rigorous lending criteria and hence, it is essential for investors to assess the creditworthiness of borrowers before lending.

Platform Risk

As P2P lending platforms act as intermediaries between lenders and borrowers, you cannot ensure safety if the platform fails or encounters financial difficulties. Hence, make sure to investigate the reputation and reliability of the P2P platform before you start lending money.

Lack of Regulation

P2P lending is less regulated in comparison to traditional banks and institutions. Though it is the result of modern innovation, it can also expose investors to higher risks. So, it is important for investors to choose platforms that follow regulatory standards and measures to protect both lenders and borrowers.

Market Conditions

This is one risk that cannot be just a P2P risk as your investment is always dependent on market conditions, irrespective of the platform you are using to invest your money. Hence, economic downturns or changes in market conditions can definitely impact the ability of borrowers to repay their loans.

Ways to Avoid Risks Associated with P2P Lending

Now, let’s talk about significant ways you can resort to avoid these P2P lending risks:

Diversification

Undoubtedly, diversifying your P2P lending portfolio can spread your investment across multiple loans. And by lending smaller amounts to a diverse range of borrowers, you can reduce the impact of defaults on your overall returns.

Research and Assessment

You must thoroughly research and assess potential borrowers before lending money as it would reduce the credit risk. P2P platforms often provide information about the credit histories and financial stability of the borrowers.

Right Platform Selection

You must select a reputable P2P lending platform like 13 Karat as it is important for the safety of your investment. 13 Karat is a platform with a track record of successful transactions and transparent practices, and adheres to regulatory standards.

What if a Borrower Defaults?

Safe Investment platforms

Whatever precautions you may take, there is always the possibility that a borrower may default on their loan. When a borrower defaults, it affects the returns of the lender. The lost principal and interest can reduce your overall profitability. However, in such cases, P2P lending platforms like 13 Karat have processes to address these situations.

Collection

When a borrower misses payments, the P2P platform initiates a collections process. Hence, they communicate with the borrower to understand the reasons for default and explore potential solutions. They may also work with collection agencies to recover the outstanding amount on behalf of investors.

Provision Funds and Insurance

P2P platforms may also create provision funds or offer insurance to protect investors from losses due to borrower defaults. These funds would cover the defaulted amount and ensure investors receive their expected returns even if individual borrowers fail to repay.

Legal Action

In extreme cases, legal action may be taken to recover the outstanding amount from defaulting borrowers.