Small Savers Helping Small Business
Peer to Peer (P2P) lending enables anyone with a small sum to save to provide support to small and medium enterprises.
The basic premise of such organisations is to spread the risk of any loan among multiple lenders so that, for example, a loan of $50,000 could be spread among 200 lenders. If the borrower defaults, the loss is similarly spread among those 200, according to the amount owed to each. At the same time, a lender with deposits of $5,000 could have that amount spread among 50 or more small business loans. The possibility of more than one, if any, of these 50 loans defaulting is very low, meaning the probability of losing $100 (2%) is very small. The other 49 loans are capable of earning double figure interest across the term of each.
The real advantage to both lender and borrower comes when lenders allow the monthly repayments on each loan accrue and be reinvested into new loans.
A single example will suffice. A man, I’ll call him John Doe, began saving with one such provider 5 years ago. Beginning with an initial deposit of €500 he has, over the years since, deposited a total of €6000. This is enabled him to support 265 businesses with loans totalling €21,750. He has earned €2,062 interest. His investment is now worth €7,797. The difference is accounted for by the provider’s fee.
Of the 265 businesses supported, 8 are in default, but the total amount outstanding on those defaulting loans is only €364 and, prior to defaulting, they had earned the saver €85 in interest.
At about the same time as John began depositing money with the P2P provider, his wife received a small legacy which she placed in a 40 day notice bank deposit. The interest earned on her €13,000 deposit to date is a measly €464.
Of course, Jane can access her money at any time by giving the bank 40 days notice, or forfeit 40 days worth of interest to withdraw it today. If John wants to access his money, he will need to cease reinvesting his returns and begin making withdrawals as the monthly repayments pile up. This will likely take up to 3 years, since the term of most loans is 36 months. And the provider places restrictions on the number of withdrawals that can be made in a year free of charge — any additional withdrawals incurring a €10 fee.
For this reason it is advisable not to put too large a proportion of your savings into such accounts. How likely are you to need to access the money in a hurry? Are you happy to be able to withdraw it in instalments over a period of up to 3 years? Once you stop reinvesting, the cash available to withdraw will accrue quite rapidly to begin with, but at a reducing rate as the number of loans outstanding reduces.
There are many organisations that exist to facilitate such transactions. This article draws on the experience of one individual using a service based in Ireland. No link is provided because this is not intended as a sales pitch for that or any particular provider. Readers who want to find such a service in their home region should conduct an internet search. Then follow up with some due diligence about the organisations they find, asking the following questions, among others:
How does the organisation assess the credit worthiness of borrowers?
Are loans graded by risk and how is this done?
What fees does the organisation charge?
How does the organisation prevent fraud?
You should find answers to such questions within a comprehensive FAQ section on the organisation’s website.
An alternative form of such investments requires investors to take an equity stake in the businesses being supported. Here there is no guarantee of a return unless or until the equity share can be sold. Again, the aim of this article is not to recommend any specific provider of such a service, only to let you know that they exist. If you think either form of investment is something you might like to consider as a home for your savings, contact a professional financial advisor or do your own research.
Disclaimer: The author is not qualified to provide financial advice and accepts no responsibility for any decision a reader might make as a result of reading the information provided in this article.