Is Peer-to-Peer Lending an Alternative Investment?

December 14, 2021

What if you wanted to get in on the ground floor of a company? After all, getting in while the investment is comparatively cheap would give you the chance to see the most growth from your investment, as opposed to coming in later. The trick, of course, is that many ordinary investors don’t have the spare capital to drop on a company.

That’s where peer-to-peer lending comes in.

Does peer-to-peer lending count as an alternative investment? Is it effective and worth the money? Here’s what investors should know.

What is Peer-to-Peer Lending?

Picture a traditional business setup. You want to start a business, but you need capital. So, you go to a bank or other lender, and you take out a loan to get started. Individual investors arrive later in the game, often after an initial public offering when stock becomes available.

Peer-to-peer lending works differently.

Peer-to-peer lending, or P2P, allows individuals to connect directly to other individuals—in other words, business owners connect directly to individual investors who want to lend them money.

This sidesteps traditional lending institutions where some would-be business owners may not meet the criteria for creditworthiness. It also opens the door for individual investors to get in on the ground floor in a way they might not have been able to otherwise since they don’t have sufficient individual capital.

How Peer-to-Peer Lending Works

Peer-to-peer lending generally uses a six-step process:

  1. Prequalification
  2. Application
  3. Approval
  4. Funding
  5. Electronic funds transfer
  6. Loan payment

Like a traditional loan, the first step is prequalification—the individual seeking investment has to meet the criteria for a peer-to-peer loan, which is usually set by the platform. If they qualify and like the terms and rate offered, they would then submit a formal application for a loan. This is when the potential lender performs a hard credit check.

Once approved, the loan moves to the funding stage. This is when multiple investors (like you) enter the picture to review the details of the loan. If you like what you see, you agree to fund all or part of the loan under the given conditions. This depends on your available funds and how much the would-be loan recipient is asking for.

Once the loan gets enough investors to meet the requested amount, all of the investors’ money is pooled together, and the platform initiates an electronic transfer of funds to the recipient. This transfer may be completed as quickly as a single business day.

After that, the loan recipient is expected to repay the loan in fixed monthly installments, plus interest. These installments are disbursed to investors based on the loan terms.

Advantages of Peer-to-Peer Lending

Peer-to-peer lending offers three significant advantages to borrowers and investors alike:

  1. Higher investor returns
  2. More accessible funding (and more accessible investment options)
  3. Lower interest rates

For investors, the biggest advantage is improved returns. Since there’s no middleman taking a cut, investors see more capital gains on their money. Plus, it’s a chance to get in on the ground floor with a business that you may not have had otherwise due to limited funds.

Disadvantages of Peer-to-Peer Lending

The biggest disadvantage of peer-to-peer lending is, of course, the risk.

Generally speaking, many borrowers who rely on peer-to-peer lending do so because they have a low or nonexistent credit rating that disqualifies them from seeking loans from a bank or other financial institution. This also means that the borrower is more likely to default on the loan.

In addition, because investors agree to accept the higher risk, the government and financial institutions do not offer any form of insurance for peer-to-peer lending in case of default. If the borrower defaults, you won’t get your money back.

Is Peer-to-Peer Lending an Alternative Investment?

So, is peer-to-peer lending an alternative investment, and is it worth it?

First, remember that the term alternative investment refers to any financial asset that doesn’t fall into one of the three conventional categories: stocks, bonds, or cash. This means anything from fine art to real estate to, yes, peer-to-peer lending. However, all alternative investments have three features in common: they’re more complex, less regulated, and less liquid than their conventional cousins.

The more prevalent question is whether or not peer-to-peer lending alternative investment is worth it. Ultimately, that depends on you as an investor.

One way or another, investors take on most of the risk in peer-to-peer lending. The risk can pay off in a big way—if the borrower’s business succeeds, and if the borrower repays the loan. Many would-be borrowers seek peer-to-peer lending because they can’t qualify for loans elsewhere, which is why peer-to-peer lending is so risky.

Whether it’s worth it depends on your risk tolerance and capacity to recover from lost capital. If you tend toward conservatism and your margin for acceptable loss is low, peer-to-peer lending may not be the right fit. But if you can afford to swallow a potential loss and you’re willing to take a bit of risk for a high reward margin, it may pay off big.

Just make sure you do your homework in advance so you know what you’re signing up for. Always use a reputable site, and always read the fine print on fees and commissions for the site in question. You should also pay careful attention to the qualification requirements and the details of the loan, as this can help you find a safer option.

Getting Started in the Exciting World of Alternative Investments

Peer-to-peer lending as an alternative investment can be worth it. It’s a question of what risks you’re willing to tolerate and what terms you’re comfortable with.

Here at Masterworks, we’re all about making alternative investing accessible to regular investors. That’s why we’re on a mission to make blue-chip art investing accessible to investors like you—after all, blue-chip art prices have outperformed the S&P 500 by 180% from 2000 to 2018. And on our platform, you can purchase shares in authenticated multi-million-dollar art from high-growth artist markets with the highest potential risk-adjusted returns. Sound good? Then fill out your membership application today to learn more.

Masterworks is a fintech company democratizing the art market. Our investors are able to fractionally invest in $1mn+ works of art by some of the world's most famous and sought-after artists.