P2P lending is one of the highest-yielding – and riskiest – asset classes available to retail investors. In Europe alone, there are more than 200 platforms where you can invest in loans. This guide explains how P2P lending works, which risks you need to understand, how the buyback guarantee really works, and how your returns are taxed.
Everything that follows is based on my own experience as a P2P investor since 2017. Please note that none of this constitutes investment advice. More on that in the disclaimer.
Which P2P platform is right for you?
You can find all the platforms that I have reviewed in in the P2P platform reviews page, the safety ranking in the re:think P2P Risk Score, and the financial stability of the loan originators in the P2P loan originator comparison. Current sign-up offers are available on the bonus page.
How P2P Lending Platforms Work
P2P platforms are digital intermediaries from the fintech sector that connect loan supply with investor demand.
These platforms operate in two directions:
- Attracting funds from investors: Platforms must attract funds from investors to finance the loans. To do so, many P2P platforms promote their company with high returns, bonus campaigns, or collateral options in case of payment defaults.
- Offering a range of loans: At the same time, P2P platforms must ensure a sufficient loan supply as well. The lenders may be directly affiliated to the P2P platform (classic P2P lending) or external lenders with no direct association with the platform (P2P marketplace model). Depending on the business model, the P2P platform may handle borrower acquisition itself or monitor the portfolio quality of external lenders.
Ultimately, P2P platforms bring together investors’ capital and the loan offerings, enabling the system to function seamlessly.
Expected Returns in P2P Lending
The expected returns from P2P lending can vary significantly, as they depend on several factors:
- Interest Rate: One of the most crucial factors is the interest rate itself, which can differ greatly between platforms. For example, interest rates may depend on investor demand or the market environment of individual lenders. Additionally, the level of collateralization for different loan types can influence the interest rate as well.
- Bonuses: P2P platforms often run bonus campaigns to attract new capital, which can boost overall returns. At the same time, new investors are frequently offered bonuses or cashback deals as well when registering on a platform. Current bonus offers can be found on my bonus page.
- Performance: Beyond the interest rate, the performance of the loan portfolio has a significant impact on the overall return. A higher amount of defaulted loans or unrecoverable debts can substantially reduce the expected return.
Advantages and Disadvantages of P2P Lending
Investing in P2P lending can have certain advantages and disadvantages. Here are some of them.
Advantages
- High Liquidity: P2P lending offers flexibility for investors in withdrawing their funds. This is facilitated through short-term consumer loans, the use of a secondary market, or special investment products that provide immediate liquidity.
- Low Entry Barrier: P2P lending has a low entry barrier, enabling investors to get started quickly and easily.
- Diversified Portfolio: Alongside asset classes like real estate, stocks, funds, and commodities, P2P lending provides an additional option for diversifying an investment portfolio.
- Automated Investing: Most P2P platforms feature automated systems that efficiently deploy funds on behalf of investors.
- Regular Cash Flow: P2P lending offers income-oriented investors a dependable way to generate regular cash flow from their investments.
Disadvantages
- High-Risk Investment: Many P2P platforms are insufficiently regulated and monitored, which has led to cases of scams and attempted fraud in the past. Even on seemingly “clean” platforms, poor risk management can result in losses for investors.
- Leveraged Loans: P2P loans are essentially investments in pre-financed loans. While leveraging can enhance returns on equity for lenders, it also increases the risk of insolvency if portfolio quality deteriorates or liquidity becomes insufficient.
- Active Investment: Although automated investing is a key benefit of P2P lending, the asset class is not entirely passive. The dynamic nature of P2P platforms means the risk profile can shift quickly, requiring investors to stay actively involved to manage their investments effectively.
Risks of P2P Lending
There are a variety of risks that can arise in the context of an investment in P2P lending. These affect either the P2P platform directly (platform risk) or its lenders (lender risk).
At both levels, there are corresponding economic risks as well as the associated market risks of the lending business. These include risk factors such as country risk, interest rate risk, liquidity risk or exchange rate risk.
Default Risk
The return to be achieved on a P2P lending platform is largely determined by the performance of the loan portfolio. In this regard, the loan default risk plays an important role in the valuation of a platform.
A default occurs when the borrower exceeds a certain period of time, usually 60 or 90 days, during which no repayments have been made in accordance with the repayment schedule.
However, a loan default does not mean that the money invested by investors is automatically lost. It is possible to recover all or part of the outstanding receivables through the debt collection process carried out after the loan default.
It is not possible to make a generalised statement about how high the default rates are for individual P2P lending platforms. The decisive factor here is the transparency of the respective platform and how openly it communicates the performance of the loan portfolio. Investors should therefore closely monitor which information a platform does or does not publish regarding the loan default risk.
Incorrectly Assessed Creditworthiness
Most lenders have a systematic evaluation process in place to assess the creditworthiness of borrowers. Depending on the credit segment, there can be significant differences. The creditworthiness of a private individual who wants to take a short-term and unsecured consumer loan of up to EUR 1,000 usually differs significantly from that of an agricultural business that wants to buy new machinery for EUR 100,000.
How well or poorly a lender has done its homework when checking creditworthiness can be seen from the NPLs (non-performing loans), which are usually published in the annual financial statements. These are non-performing loans that are very unlikely to be recovered and therefore have to be written off.
What Happens in the Event of a Payment Default?
If a payment default occurs, the P2P platforms attempt to recover the money as part of a debt collection process. As there are different types of loans, the security and recovery mechanisms are quite different.
In the case of consumer loans, many lenders are liable for investors in form of a buyback guarantee, whereby loan defaults are repaid out of their own pockets. The prerequisites for this are the economic conditions.
In the case of mortgage-backed loans, such as property, it depends on the proceeds from the sale of the collateral how much money investors will get back in the end.
With other platforms, on the other hand, there is no protection, which is why investors have to bear the default risk directly.
Insolvency or Closure of a P2P Platform
Another risk associated with P2P loans is insolvency, i.e. the inability of a platform to pay. Most P2P marketplaces are usually asset managers who receive a commission for their brokerage activities depending on the loans financed.
In this respect, investors should familiarise themselves with the business models of the individual P2P lending platforms and their financial situation. The audited annual financial statements, if they are published, provide valuable insights into this.
Buyback Guarantee in P2P Lending
A few years ago, Mintos established the so-called Buyback Guarantee (also known as Buyback Obligation) on its P2P marketplace. This concept, which aims to eliminate the supposed default risk for investors, was subsequently adapted by many P2P platforms. Today, it is one of the key security features of lenders who finance unsecured consumer loans.
How the Buyback Guarantee Works
The way the buy-back guarantee works is relatively simple: As soon as the loan is in delay for a certain period of time, the issuer (the lender) undertakes to buy back the receivable from the investor. As a rule, this period is 60 days. With some P2P platforms, however, the repurchase obligation period is 30 or 90 days.
In addition to the outstanding repayment, the accrued interest is usually also reimbursed.
Which P2P Platforms Offer a Buyback Guarantee?
The buyback guarantee can be found on many P2P platforms where lenders offer unsecured consumer loans. These include lenders on Mintos, Esketit, PeerBerry or Income Marketplace. P2P platforms that offer collateral for the loans (mortgages, land, machinery, etc.) generally do not have any form of buyback guarantee.
When Does the Buyback Guarantee Kick In?
The timing of the buyback obligation varies greatly from one P2P platform to another. With Swaper or Robocash, the buyback is supposed to take place after 30 days. With Mintos, PeerBerry, Esketit or Income Marketplace, on the other hand, it is 60 days. The longest buyback period has Debitum with 90 days.
Advantages and Disadvantages of the Buyback Guarantee
The major advantage of the buy-back guarantee is that the supposed default risk of the loan is eliminated. This gives investors reliable repayments and a predictable cash flow. Provided, of course, that the buy-back guarantee is honoured.
The disadvantage of the buy-back guarantee is that investors may be blinded by a “false sense of security”. This is because honouring the buyback guarantee, which is promised by the lender itself, is only as secure as the payment morale of the issuer itself. If the issuer has financial problems, the shift in default risk will fall back on the investor.
How are P2P lending returns taxed?
Interest earned from P2P lending is taxable income in virtually every country – how much you pay depends on where you are tax resident. Unlike a bank or broker, P2P platforms generally do not withhold tax for you, so you are responsible for declaring the income yourself.
Most platforms provide an annual tax report that summarises your interest income. When in doubt, consult a tax adviser familiar with your country’s treatment of foreign investment income.
P2P Lending FAQ
P2P loans are financed by retail investors through online platforms – without a bank as intermediary. Investors earn interest in return, but also carry the default risk of the loans and the risk of the platform itself.
No. P2P lending is a high-risk asset class in which a total loss is possible in the worst case. However, risks differ significantly from platform to platform. The re:think P2P Risk Score provides a systematic comparison across five categories.
Interest rates vary considerably between platforms, typically ranging from 8% to 14%. After accounting for possible defaults, a realistic net return expectation is between 6% and 10%.
On this blog you will find in-depth platform reviews, continuously updated comparisons and scores, and news from the P2P lending market several times a week.