Does removing banks and lending to strangers directly to earn better returns sound exciting to you? Yes or no, to save you some trouble or to earn better interest, you have to understand how P2P lending works.
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Do you ever wonder how the bank works? How do they pay 4-6% interest on your savings?
In a simple way, the bank collects money from us as deposits and raises some more money from the RBI as a loan.
Then the bank uses this money to lend to individuals, businesses, etc. While seeking to reduce the default rate, the bank tries to maximise its returns. These returns from the loan can be anywhere from 15 to 24% on average.
And from those returns, the bank pays the interest to the RBI and us (depositors) for lending them money.
Now to save guard our deposits, the RBI has introduced some rules like deposit insurance, deposit reserves, etc.
These rules make banks more conservative while doling out loans to individuals and businesses. That’s why most borrowers with low credit scores or ratings find it difficult to take loans.
This raises an opportunity for NBFCs (Non-banking Financial Company) to step in and lend indiscriminately at higher interest rates. Most NBFCs won’t be able to accept deposits from us. And they are less regulated by RBI when compared to the banks.
These NBFCs have introduced P2P (Peer to Peer) lending in India. What happens here is, instead of you depositing your money and the bank lending to others. You lend to individuals and businesses directly.
Yes, these NBFCs provide us with a platform where we can select whom to lend our money to and earn interest from them.
And again, to safeguard us, the RBI has introduced some rules like our exposure to one borrower at a time shouldn’t exceed 5%, and you can’t lend more than ₹10 lakhs. If you want to invest more than ₹10 lakhs in these P2P lending platforms, you have to provide a net-worth certificate.
How does the P2P lending process work?
When a borrower approaches the P2P lender (Lendenclub, Liquiloans, Faircent, etc.) for a loan, they submit all kinds of documents for verification.
Then, these P2P companies do their due diligence and verify all the information. After verification, they post the borrower’s requirements on the platform for the lenders to see.
We can go through the details provided on the platform and decide whether to lend them our money. If you agree, based on the platform, you will lend 1 to 5% of the loan amount. They will collect the rest of the loan amount from other lenders. This reduces your risk if the borrower defaults.
And let’s say you don’t want to do all this research work of selecting whom to lend to. Most P2P companies have separate automated features for you. Here, the platform will automatically lend your money to various borrowers while following all the rules and regulations.
Also, companies like Cred (Cred Mint) and 12% club have partnered with P2P lending NBFCs to offer you an automated P2P lending facility.
What are the charges and returns of P2P lending?
Like banks, all P2P platforms have different charges. As these are unsecured loans (No collateral), they charge borrowers an interest rate between 12 to 24%.
Apart from the interest charge, the borrowers also have to pay the processing fee, listing fee, etc.
And for lenders, some platforms charge joining fees, and some don’t. Most charge an investment fee of 1-3% of the invested amount, which can be deducted from the first EMI you receive as a lender.
Directly or indirectly, you pay a management fee of 1-3% when you use their automated lending facility.
On average, you can expect an interest return between 8 to 12%. Remember, these returns are not guaranteed.
Is it safe to invest in P2P lending?
Many people compare the returns of savings accounts and P2P platforms. But they forget to look at the risk factor.
Your money in the savings account is safe to some extent. Banks insure your money in savings accounts for up to ₹5 lakhs.
Whereas lending in P2P lending provides better returns, it is not guaranteed. If the default rate rises, your returns might be lower, and you might lose your money too.
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