The reason why many entrepreneurs invest in P2P lending

Peer to peer lending is a concept made famous by platforms like Lending Club and Prosper that allows investors to contribute towards loans and earn a piece of the interest paid.

For the past decade, peer to peer (P2P) lending has steadily grown as an option for small business owners and individuals who need to borrow money. At the same time, investors have experimented with lending on the platforms in an effort to earn interest and diversify their investments. Although some of these companies have had their ups and down — especially on the stock market — P2P continues to rise in popularity and could be a good option for investors looking to try something different.

The way it works is that borrowers are approved by the platform — using both traditional factors such as credit scores as well as employing some proprietary algorithms in order to determine creditworthiness — before their loan is listed. This data is then supplied to investors who filter through numerous options and make their own decisions about who the back.

As with most (if not all) investment opportunities, peer to peer lending has its own set of risk to reward propositions. For example, while most platforms do have minimum requirements that borrowers must meet in order to get approved, some are decidedly less creditworthy than others. Loans made to these individuals do command a higher interest rate, which may be attractive to investors, but also have a higher tendency to default.

For that reason, it’s important to diversify your P2P portfolio and hold a variety of notes. It’s also why, for example, Lending Club allows investors to contribute as little as $25 toward any loan. Furthermore, the company has said that 99% of investors who hold over 100 notes of the same size see positive returns.

The rise of peer to peer lending has also led to some unique twists on the basic idea. One example of this is small business lender Able Lending which offers a hybrid of crowdfunding, P2P, and institutional funds in an effort to help entrepreneurs raise capital. A portion of each Able loan is funded by friends, family, and fans of the business owner that are invited to participate and earn interest. Able calls this model “collaborative lending” — a term that seems particular apt and will likely be replicated if successful (this review of Able Lending provides a few more details on how their platform works).

Despite experiencing its fair share of stumbles and setbacks over the years, peer to peer lending is still going strong. As a result, there may be an opportunity for investors to make money while also helping entrepreneurs and others in need. Whether you ultimately choose to use Prosper, Lending Club, or an alternative platform like Able Lending, just be sure to diversify your loan notes and carefully consider each loan you make.

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DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.