One of the biggest differences between the wealthy and most other people is that the wealthy earn interest and everyone else pays interest. They earn interest by making their money work for them, instead of working for money.
To make my money work hard for me I look to get the biggest return on my money. Right now though, with a shaky stock market, record low interest rates and real estate values that are only expected to slide further it’s hard to make a decent return on your money. However this investment strategy though is knocking the socks off all other investments out there.
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Investing In the Internet Age
Peer to peer lending has flourished in the Internet age. The internet acts as a middle man that puts borrowers in touch with lenders. Cutting out the bank reduces the cost of the loan which translates to better rates for borrowers and better returns for lenders (YOU). Lending money as a micro banker is a good way to make extra money, diversify your portfolio, and create another income stream. In the next couple of years, this method of investing could easily do better than the stock market.
If you’re not familiar with the term peer to peer lending or how it works, it’s actually quite simple. The whole process works somewhat like an EBAY auction. A listing is posted. There is a set time period for lenders to review the loan request and bid on the loan. Once the bidding process is closed a lender and borrower are put in touch.
Unlike traditional lending done at banks and credit unions, a person will visit a peer to peer lending website to apply for a loan. A borrower will post their loan request and the lenders in that peer to peer community can review it.
After reviewing all loan requests you can choose which ones to bid on. You’ll be in competition with other lenders so you’ll want to put together your best offer when bidding on a loan. Your bid will include how much you are willing to loan and how low you will go with your expected return. As soon as the bids close, the ones with the lowest rate will be combined into a single loan.
Lenders invest in “notes” that represent small portions of an individual loan. The minimum investment is $25 per note, so you can really spread your risk around if you wish.
Each month, as the payments are received from borrowers, your money gets deposited into your account (after deducting a small fee). You can either withdraw these funds or reinvest them in additional notes. While the loans themselves are not insured, your un-invested cash is FDIC insured.
Assessing Your Risk
There are dozens of peer to peer lending websites out there. Lending Club boasts an average rate of return of 9.65% for its lenders. That’s significantly higher than what the stock market, real estate investments or an investment at any bank has yielded in the past two years.
LC allows lenders to bid on three year or five year loans. Borrowers must have a credit score of at least 660 and their debt-to-income ratio (excluding their mortgage) has to be less than 25%. They can’t have any current delinquencies, recent bankruptcies (past seven years), open tax liens, charge-offs, or collections within the past twelve months. In other words, they have to fit the profile of a reasonably responsible borrower.
According to an article in Businessweek, Propser.com is the leader in the peer to peer lending industry. It accounted for 80% of total loan volume in 2008. Prosper.com estimates its lenders receive on average a 10.4% return on their money. That beats the pants off of any other investments out there right now! Better than what you’re earning at any bank or credit union right now and better than the stock market.
Prosper borrowers are people with good credit (a credit score of 640 and above). Borrowers can request loans up to $25,000, and they indicate the maximum interest rate they wish to pay. All Prosper loans are unsecured three year personal loans. The interest rate is fixed for the life of the loan, and can be automatically deducted from the borrower’s bank account.
As you can see the people that borrow from these websites are not scam artists or dead beats. Before they can even request a loan they go through a screening process and have their credit run. Both of which helps to minimize your risks.
To further reduce your risk, spread your money around to several loans, a mix of low and high interest. Most of the current peer to peer websites allow sharing of loans so that the risk is spread around. For example, if someone needs a $9,000 loan, instead of one lender offering the whole amount, thirty lenders may each provide $300. The interest rate payments will be equally divided among those lenders based on much of the loan they purchase.
Ideally you should be lending to 30-50 people. This will spread the risk over multiple investments, which is a good investment strategy in an industry. I believe no single loan should account for more than 2% of your portfolio. The more loans in which you invest, the better your chances are in achieving the average expected return.
The best part about making money with peer to peer lending is how hands off it can be. Lending facilitators like Prosper.com and others take care of every aspect of the whole transaction. They present pre-qualified borrowers to you, collect the monthly payments and deposit the money into your account each month. The process is totally automated so you don’t have to keep on top of borrowers or chase anyone down for money. You just sit back and collect the money.
Make your money work hard for you! This investment strategy is earning far better rates of return than anything else I’ve seen out there right now.
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Keeping Money in Your Pocket,
Nancy Patterson
