The Investment Scientist

P2P Lending: A New Asset Class?

Posted on: July 27, 2013

P2P Lending

P2P Lending

Last night I was “wasting” time on Google+, when I stumbled upon Joe Udo’s blog where he had written about how he made an 11.3% annualized return with P2P lending. The next thing I knew, it was past midnight and I just had spent three hours eyeballs deep in the subject.

Let me first tell you what P2P lending is. P2P stands for person-to-person or peer-to-peer. P2P lending is the practice of lending to strangers, enabled by technology and the web.

The two leading companies in this arena are LendingClub and Prosper. Between the two of them, they’ve enabled nearly $2 billion of lending between investors and borrowers. However, that still pales to the total US consumer credit of $1 trillion.

I am super excited about P2P lending! Let me tell you why.

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Nobody likes a middleman, and P2P cuts them right out of the equation! Have you noticed that banks are charging you 15% to 23% on your revolving credit card debt, while paying you a paltry 1% interest on your savings? That’s a major rip off! On top of that, they still need taxpayer bailouts from time to time – that’s our money as well.

With those big bad banks out of the picture, borrowers with good credit can borrow much more cheaply, thereby keeping way more money in their pockets.

For investors, it is even more exciting! Traditionally, there are only three fixed income asset classes: Treasuries (lending to the Fed) which pay nothing (1-2%); Municipals (lending to states) which pay peanuts (2-3%) and Corporates (lending to corporations) which pay between 4% and 7% depending on credit quality.

Now that there is P2P lending (lending directly to individuals,) investors can earn between 6% to 15% in returns! I call this a new asset class. It is riskier than corporates, but like all risks, it can be managed, and the rewards are superb.

Unfortunately, P2P lending is not yet legal in my home state of Maryland, even though it is in DC and Virginia. You can bet that I will be calling my state legislators for help with that one.

I can’t wait to dip my toes in and test the waters so that maybe one day I can add P2P to my clients’ asset mixes.

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2 Responses to "P2P Lending: A New Asset Class?"

In Real Estate Investing, “hard money”, or a loan from an individual is an available option to the investor. In 2009, when I bought my first investment property, bank lending was frozen. TARP and the rules handed down made it impossible to borrow on a real estate venture, no matter your ability to pay or credit score.

I knew it was perhaps the greatest buying opportunity of my lifetime in Real Estate, so for the first deal I used P2P cash to buy the property.

Terms are negotiable, but it usually is close to 12%/annum. Some lenders require you pay the interest for the full term, usually 1 year, whether you need the cash for the year or not. You can pay back early, but it costs the same. In my deal I moved it to 30 yr fixed rate to maximize cash flow as soon as we could, but I had no penalty for early pay.

There are probably P2P loans for home mortgages too, since the lender would earn a good deal more than saving account or CD. In Ohio they regulate the interest of a long term P2P mortgage, probably many other states do to.

I would like to see more of that type of financing availability and eventually phase out the government’s involvement in home loans. It would put private lenders more in the driver’s seat and the lion’s share of profit. It might add a bit to the interest, but long term, it would avoid the bubble built by an organization too big to fail and driven by political pressure, handling home loans.

People in the know, like Michael, could form a small group of venture capitalists, pool some cash, and make well secured loans to people unattractive to banks. Divide the fees, charges, and interest.

There are many people after the Frank/Dodd bill that are “well qualified” to borrow, but they don’t fit the pigeon hole that the law requires, so the banks simply must pass.

Ron,

Thank you for the great personal story you share with us. On Prosper and Lending Club, the P2P lending is not one on one, it’s many to many. Say if you need $10,000, you might borrow it from 100 people each lend you a different amount. Likewise if you have $10,000 to lend, you may lend it to 100 people for $100 each. This reduces a risk to lender and thereby reduces the cost of capital to borrowers as well.

Just wonder did you borrow your cash from one person? or from a bunch of them?

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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