Peer-to-peer lending can earn you a higher rate of return

Mar 15, 2017

I’m not much of a risk-taker when it comes to investing. I live by the old adage, “Be wary of investments you don’t understand.” That limits a lot of my options.

Plus, I’ve been writing about personal finance for almost seven years now. I’ve learned how the markets work. And for the most part, they seem to work by milking average investors like you and me of our hard-earned money. (Don’t believe me? Read the Pulitzer-prize winning Den of Thieves; it’ll make you never trust a banker or broker again.)

For the past few years, all of my investments have been in two things: municipal bonds and index funds. These are investments I understand. They’re investments with very little “drag” — there aren’t a lot of brokerage fees being skimmed off the top before I get my share. I’ll never earn spectacular returns, but I feel that I’m never going to suffer catastrophic losses either.

Lately, though, another investment option has caught my eye: peer-to-peer (P2P) lending.

P2P lending basically works like this: Somebody who needs to borrow money goes to a company like Prosper or Lending Club and applies for credit. Once approved, the borrower is assigned to a risk category, which determines the interest rate of the loan(s) he or she receives. Then, that loan is funded by an individual investor (or group of investors) who acts as the lender.

This turns out to be a good deal for borrowers because they get a better interest rate than they might through a traditional bank loan or credit card. But it’s also a good deal for lenders because they earn a higher return than they can through a savings account or certificate of deposit. (And, of course, it’s a good deal for the company arranging the loan because it skims money off every transaction.)

P2P lending has been around for six or seven years, but I’ve always been wary of it until now.

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