5 key things to earn high returns from P2P lending
You may be already investing or considering to invest in the new age option of Peer-to-Peer (P2P) lending in India. With RBI granting the NBFC-P2P license to around 15+ players, the p2p lending industry has kicked off for a higher share of retail lending. This has been followed up with recent increase in investment limit from Rs 10 Lacs to Rs 50 Lacs. The trend indicates a positive stance of regulator as well as the government for P2P lending Industry. In this context, here, we have covered the 5 key things to earn high returns from P2P lending.
The P2P investment concept
The concept of P2P investing or lending is quite simple if compared with stocks, derivative trading, commodity trading, mutual funds etc.
You lend money to individuals by using the marketplace provided by a P2P lending platform. While doing this, you get to choose from a multiple set of loans listed in the marketplace.
You may compare this with shopping on Amazon or Flipkart.
You visit an e-commerce store either using the web or mobile app. Out of the multiple choices of products listed in the marketplace, you choose the one’s that fit your requirement. You transfer money and get the order delivered.
Instead of the products, P2P lending has borrower requirements listed in the marketplace. Most platforms provide you information about the amount of loan required, tenure, interest rate, other demographic details & credit history etc. (You may have a look here at a typical P2P lending marketplace).
So in case of P2P lending, you select the loan, decide the fund you want to invest and transfer money online. You get a legal agreement for payment from the borrowers, who pay off EMIs to you from the next month.
So in essence, you act as the bank and lend money to earn interest. Typically, most of the platforms claim to provide you between 12%-36% p.a. returns.
However, in order to maximize your returns, here are 5 key things you need to leverage while investing.
1. Diversify from start
When you start with P2P lending, the marketplace may look like the choices below and you need to choose the best hat. Best hat belongs to the borrower who will pay you back all EMIs on time. However, on the face of it is a really difficult choice to make.
The solution is however simplified by diversification. You choose multiple hats from the start.
In case of P2P lending, if you are starting with Rs 5000 and you are lending money to only one borrower, you are speculating. This can be compared to a naked call option trade or buying a share in the hope of market going in your favor. You need to avoid such a position.
Instead, you start with Rs 20000, split across 4 loans and observe how things appear in the next month. If you get timely repayments from all 4, then you must consider yourself really lucky or the platform is having really good underwriting & collection efforts. However in almost all scenarios, delays are inevitable in P2P lending. Mostly, you need to learn to deal with them.
Based on the next month performance, you narrow down your profile selections & continue diversifying.
2. Look at the credit history
There are 4 credit bureau’s in India – CIBIL, Equifax, Experian & High Mark. You would notice that different P2P lending platforms use one or multiple of the services from these bureaus. These organizations keep a record of borrower’s repayments history, number of current loans, inquiries etc. along with a credit score. Usually, you would notice P2P lending platforms provide loans to either first time borrowers with no credit history or people with credit scores ranging from bad to good.
For your portfolio, you should try to choose the borrower credit score in a band which gives the best returns for your risk. For e.g. let us say, you have a borrower paying you an interest rate of 36% p.a. with a CIBIL score of 500 and another borrower paying an interest rate of 24% p.a. with a CIBIL score of 680 – you might want to make the second choice.
In the credit report from P2P lending platforms, apart from the score, do check out if the borrower has existing loans as that lowers the repayment capacity.
3. Guage the ability of the borrower to repay
If you diversified your portfolio across multiple borrowers and ensured the credit records are decent, you may want to further optimize on few of these factors.
a) Housing type – Check the percentage of amount you have split between these 3 accommodation types broadly – parental house, self owned house, rental house, company provided accommodation etc.
You may want to check if the P2P lending platform has physically verified the residential address.
b) Number of dependents – Lower the number, better it is for repayment ability. Keep a tab on your portfolio split between less than 2, less than 3, less than 4 and more than 4 dependent segments.
c) Debt to Income (DTI ratio) – a criteria used by banks while providing loans is also useful while selecting borrowers for P2P lending. If DTI is less than 0.5, it can be a really good deal. On the other hand, you may want to check if DTI is more than 0.8.
4. Check the income type & magnitude
When it comes to lending, stability of income source matters. During unprecedented economic situations like COVID-19 and subsequent lockdown, there is a direct impact on business. This percolates to both the classes of borrower – salaried or self employed.
While choosing the borrower, you need to check about the stability of income source. Salaried individuals with stable long term work profile at a company indicate a positive sign. Similarly self employed individuals, having owned house and business set up in an industry which is least affected tend to have lesser delays/defaults on repayments.
Once you start scaling your portfolio, you would notice that delays are inevitable in P2P lending. What you need to check is the, compensation mechanism against those delays. In most cases, you may get late payment fee, charges, extra interest etc..
However, you would be able to get the best results if you lock in your investments at the right places for at-least 12-18 months duration. By locking in, you also re-invest your EMI and fee repayments to increase compounded returns. This further ensures any loss due to default is covered up by investments in other borrowers.
Concluding remarks on 5 key things to earn high returns from P2P lending
If you choose your borrowers in a proper way, there is a high probability of earning better returns than debt instruments like PPF, PF etc. You may even outperform the mutual funds in the long term. Once you crack the knack of figuring out the right borrower profile, you may leverage compounding & try to double your money in 2-3 years.
Disclaimer – The view and analysis presented here is based on independent estimates and assumption by Fintox. The reader must rely on self – judgement for making an investment decision.
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