P2P Lending: Easy credit for borrowers and good returns for investors?
During 2020-21, the Reserve Bank of India cut interest rates to support the Indian economy to emerge from the Covid-19 induced economic slowdown. Due to this, banks also reduced interest rates on their fixed deposits. Most big banks were paying around 4.9% p.a. on one-year fixed deposits. As a result, investors started looking for alternatives to low-interest rates on bank fixed deposits. One such alternative is P2P lending. This article will discuss P2P lending, which can provide easy credit for borrowers and good returns for investors.
What is P2P lending, and how does it work?
Peer-to-peer (P2P) lending is a mechanism in which an online platform brings together borrowers (who need loans and are willing to pay interest) and investors/lenders (who have surplus funds and looking to earn returns on it).
How does it work for a borrower?
A borrower can approach a P2P lending platform for a personal loan. The platform will do the credit underwriting on various parameters such as CIBIL score, income, profession, existing loans, etc., and assign a rating. They will then list the borrower profile on the P2P platform with loan details like amount, tenure, interest rate, etc.
How does it work for a lender/investor?
Interested investors can check the borrower profile and participate in funding the borrower's loan requirement. Multiple investors can come together and fund a single borrower. Once a borrower receives 100% funding commitments from lenders, the P2P platform signs the loan agreement with the borrower. The platform will share the loan agreement with all the lenders. The platform will debit the bank accounts of all lenders for their share of investment, and the entire loan amount will be credited to the borrower's bank account.
From next month, the EMI amount will be debited from the borrower’s bank account, and it will be credited to the bank accounts of lenders/investors as per their share in the loan.
RBI regulations for P2P lending platforms
The Reserve Bank of India (RBI) regulates all P2P lending platforms. The RBI has categorised P2P lending platforms as NBFC-P2P under the broader category of NBFCs. Some of the important regulations laid down by RBI for P2P lending platforms include:
There are strict minimum capital requirements for getting into the P2P lending business, and this amount has to be maintained throughout.
- The loans given can have a maximum tenure of up to 36 months
- An investor can lend up to a maximum of Rs. 50 lakhs to borrowers across all P2P lending platforms taken together.
- An investor cannot lend more than Rs. 50,000 to a single borrower across all P2P lending platforms.
- A borrower can borrow a maximum of Rs. 10 lakhs from all P2P lending platforms taken together.
Borrowers: Benefits of borrowing from P2P lending platforms
For borrowers, some of the benefits of borrowing from P2P lending platforms include:
A simple and easy registration process - Any borrower can register for a loan on a P2P lending platform using their simple and easy registration process. The entire registration process is online, and the borrower doesn’t need to visit their office.
Fast disbursal of loans - The disbursal of loans through a P2P lending platform is fast. Some platforms provide loans within a day.
No prepayment penalty - A borrower can make partial or complete pre-payment of the loan at any time without any penalty.
Low-interest rates - Most P2P lending platforms categorise borrowers into various categories based on their credit profiles. If the borrower has a good credit score and other parameters are also good, they can get a loan at low-interest rates. The higher the risk, the higher the interest rate will be.
- Loan without CIBIL score or low CIBIL score - Some P2P lending platforms provide loans to borrowers who don’t have a CIBIL score. Some P2P lending platforms also provide loans to borrowers with a low CIBIL score (less than 750).
Lenders/investors: Benefits of lending through P2P lending platforms
For lenders/investors, some of the benefits of lending through P2P lending platforms include:
High returns - P2P lending platforms can provide you with 8% to 25% p.a. interest rates on loans. But, please note that the higher the interest rate, the higher will be the risk.
Diversification opportunity - P2P lending platforms are one of the ways of diversifying your investment portfolio. Asset allocation requires an investor to diversify into different asset classes such as equity, fixed income, gold, real estate, etc. Within fixed income, P2P lending can be one of the diversification options.
Regular monthly cash flows - By lending on P2P lending platforms, an investor can get monthly cash flows in the form of monthly EMIs. A borrower pays a monthly EMI that has the principal and interest component. The investor can use the monthly cash flows (received in the form of EMIs) as their second income source.
- Lending to verified borrowers - P2P lending platforms do the credit underwriting of borrowers based on 100s of parameters. To evaluate the borrower, they go beyond traditional parameters such as CIBIL score, monthly income, existing loans, etc. Based on this, they give the borrower a rating based on which an investor can choose whether they would like to lend to the borrower.
Risk of loan default
For an investor, P2P lending is a good way of diversifying their investment portfolio. However, an investor needs to understand there is a risk of the borrower defaulting on repayment. It can lead to loss of principal as well as interest. While the P2P lending platforms assist in the recovery process, if it fails, the loss has to be borne by the lender.
Asset allocation: Don’t put all your eggs in one basket
P2P lending is an emerging industry and has good promise for investors. However, investors need to follow appropriate asset allocation and diversify their investment portfolios. As part of this diversification, they can allocate a small portion of their investment portfolio to P2P lending. However, investors should not go overboard and should not invest a major portion of their investment portfolio into P2P lending.
Investing in mutual funds with the Glide Invest App
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