Investing in Peer-to-Peer Loans? Think Like a Bank

Peer-to-peer loans have become the next biggest thing in investing. The stock market may be producing disappointing results but the new social trend in lending is proving to be a nice alternative – and a great way to diversify one’s investment portfolio.

Lending Club, the most popular peer-to-peer lending network today, is one such company where average Joe’s like you and I can lend to people and collect interest. So, we are the ones making a profit – not the corporations we call banks.

You get to review a large number of loan requests. Information that is available for you to review includes a job profile, home ownership, credit history, and delinquency history.

You Are Not a Savior
Now, it is commendable to want to invest in a loan for someone who is struggling to pay their basic living expenses but needs a loan to pay medical bills. Regretfully, I have to say that it is terrible loan to invest in. Your only goal when it comes to peer-to-peer lending is to gain a profit – a goal that aligns with that of banks.

Though the increased sense of pride is a desirable perk for helping someone out, you won’t be feeling so honorable when the borrower begins defaulting on a loan that you funded. A loan gone bad will leave you feeling cheated with a frown on your face as you watch your money disappear. Don’t ever deviate from your role as an investor. You are not a savior.

Think Like a Bank
Banks are greedy and their money means everything to them. No wonder they are able to make billions of dollars a year. When you have invested in a peer-to-peer loan, you act as the bank. It is your money at risk. Assuming the same attitude that banks use would help replicate their results.

• Define a lending criteria.
  There are hundreds of peer-to-peer loans that are waiting to be funded as there are also thousands of mortgage applications waiting to be reviewed. So, you must weed out loan candidates that do not fit your taste. Banks will immediately turn down anyone with bankruptcies. What are some details of a loan or a borrower that you’d immediately reject?
• Seek a strong ability to repay.
  The moneymaker of loans is interest. Loans are a long-term commitment and the longer a loan, the more interest you collect. Therefore, you need to find someone who is stable and consistent with making payments. A person who has low job security or tight cash flow after expenses is an unattractive borrower because of their unreliable ability to repay the loan. Many lenders on Lending Club inquire on a borrower’s job position, length of employment, and monthly expenses. A steady job with good positive net income after expenses is ideal.
• Shun all emotion.
  The intimate relationship between lender and borrower creates an increased tendency to sympathize for others. Such glimpses of human emotion are absent with the procedures that banks take when lending. It’s not just you who feels sorry for the single mother raising three children with a low-income job who needs a loan for medical treatment – everyone feels sorry too. But, you are putting your money at risk. If you lent to this struggling mom, you may well be giving money – not lending.
• Ask questions and analyze the information.
  Peer-to-peer loans are more personal that the loans handed out by banks. That’s a reason to get to know more about the borrower. A good amount of information would better assist you with deciding whether or not you should lend to loan candidates. Discovering a discrepancy in their information may help you dodge a bullet. Things like a divorce, kids going to college, or the lack of health insurance could be hints of impending increases of financial burden which could jeopardize their loan repayments.

Is thinking like a bank a foolproof way to invest in peer-to-peer loans? While it is obvious that defaults do occur (just look at how bad mortgages took down our economy), such a strategy is an imperative approach when it comes to investing – not just peer-to-peer loans.

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