What would determine a p2p lending more risky or more secure

Question

The title doesn't describe the full picture so I would like to give some more background information.

So basically I've been aware of the p2p lending existence but I've always been somewhat hesitant to put money online no matter what the investment is.

The platform that I'm considering is operating in eastern/central Europe and a lot of the credits that are offered are small credits (like between 1/2 to 1 average monthly salary). The percentage for these credits when they are not overdue or with some other problems are around 5.5%. Some of the companies that offers to buy credit from them are well known in the countries they operate which gives me a little more assurance that most of the credits will be collected.

So basically the main pros that I see are:

1. I have some personal observations on the companies who offer those credits

2. The credits that I'm looking to invest into are generally for small amounts (which I guess is both - good and bad). For me this is more of a positive since less money = more likely to be given back. However one can argue that the people who are taking such credits are not exactly the most financially reliable, but again, here comes point 1, that I have some idea how those companies works so I expect them to be able to collect most of the credits they've given

3. The credits that I am willing to invest to are generally short/mid term (expected time for paying the credit is between 30-60 days) which is important for me in terms that as I've mentioned above, I have some inner struggle to invest money online so being able to invest/collect in a relative short period of time, even if it's not that high of ROI is preferable to me.

So in my mind I have this picture - I put some money into this platform, I buy a credit which, if everything goes well, is paid within 30 to 40 days, after which I happily collect my profit no matter how small it is and make decision whether or not I would like to proceed with this.

However, as everything in life, this sounds too good to be true. If it was that easy - you give some money away for a month and then you collect them with 5% interest then I don't see a reason why all people, especially those with more money, don't just do that? Something changing drastically within 30 days is highly unlikely so the risk doesn't seem that big. You just give some money, and after 30 days you collect them back with 5% interests and then you can do it again.

So what is the problem with this picture? Why are not all credits bought by rich people/companies and just making profits? What are the possible pitfalls/problems that I should be aware of before investing anything?

Answer 1

When it comes to loans, not all loans are good. There is always the risk that the debtor goes bankrupt and won't pay back the loan. Such a "bad loan" creates a huge damage to the creditor (you) because the creditor doesn't just lose out on their expected interest, they lose the whole investment. Investments into bad loans were one of the triggers of the 2007/2008 financial crisis.

If someone wants to sell you something and promises it will make you more money than you paid for it (in this case loans) then you should always wonder why that person wants to sell that thing instead of keeping the profits to themselves. Possible reasons are:

1. The whole platform is actually an organized scam.
2. The platform assumes that most of the loans they sell are bad. If they would take all these loans themselves, the losses from those who default on their loans will on average exceed the profits from those who do not. So they want to get rid of all these potentially bad loans.
3. Maybe some of these loans actually are good, but the platform doesn't have the resources to do their due dilligence to find out which of them are and which are not, so they are outsourcing that work to you.

In case 1 and 2, you really don't want to give these people any money.

In case 3, your trump card is your ability to "have some personal observations on the debtors". If you are actually able and willing to estimate correctly which are stable and honest enough to pay you back and which are not, then you could give it a try. So whether or not you should do this depends on your ability to judge them correctly. That means you need to investigate these debtors:

• In case of private people, that would involve looking at their personal finances and credit history.
• In case of companies, that would involve meeting with the owners in person, inspecting their facilities and looking into their books.

If you want to minimize risk to a reasonable amount, this might be a lot of work. Think carefully if the assumed profit is actually worth that time.

Also, most of these debtors will be bad. Money is very cheap in the Eurozone right now due to the 0% central bank interest rate. European banks offer short-term loans for historically low interest rates. So if anyone is willing to pay 5% interest on a 30 day p2p loan, you can assume they already tried with several regular banks but were rejected due to obvious problems. The only people you can hope to profit from are those with obvious problems but non-obvious unique advantages which don't fit into the banks standardized appraisal systems.