Young Americans are not investing in the stock market.

There are a lot of reasons for that.

For starters, student loan debt has left young people rationing their income and has made them more risk-averse when it comes to money. Another reason less money is going towards stocks is that investment opportunities that offer  better risk/reward ratios have come on the scene thanks to technological advances.

One of the most interesting of these investment vehicles is peer to peer (P2P) lending.

Peer to peer lending is when a borrower sources their loan from other individuals rather than banks. This arrangement allows for easier borrowing opportunities and enables investors to collect valuable interest.

If you’re interested in investing in peer to peer lending, it’s important that you understand key things about this money-making vehicle first.

Here’s what to keep in mind…

1. Not All Peer to Peer Lending Companies Are Equal

When you Google peer to peer lending, you will get absolutely trounced with results. It seems like today there are hundreds of companies that are trying to get in on the investment strategy by setting up platforms that connect borrowers with investors.

It’s very important that you research on each of the platforms you’re considering investing through. Many of them are illegitimate and present a high risk to your financial livelihood.

Sometimes formally trusted lending companies have lied to investors about key statistics like loan risks, earnings, delinquent payments and more.

Any company with a history of dishonesty should not touch your investment dollars.

2. There May Be Income Requirements to Lend

Many people flock towards investing in peer to peer lending because they figure that it might be fun to lend their pocket change and get paid for their troubles.

Unfortunately, there are barriers to entry in lending through peer to peer platforms.

Laws dictate that investors must meet certain income requirements to stake their money as an “accredited investor“. These requirements tie many platform’s hands if an investor that’s looking to build their small amount of wealth is trying to stake what they have on borrower’s interest.

Income requirements may vary between lending platforms, so if you’re interested in investing in loans, go for it and see how your application fares. Just don’t lie when you’re asked questions.

Lies may come back to bite you and could even interfere with your ability to pull money out of your investment account.

3. High Interest Rates Mean High Risks

When you first start out investing in peer to peer lending, you’ll be taken to your platform of choice’s lending portal. In that portal, you’ll see a variety of loans that need funding.

Each of the loans you’re presented with will carry different terms. These terms will be spelled out in your portal.

Key areas of variance between loans will regard how many months the borrower has to pay their loan back and the interest rate that their loan carries.

Obviously, the higher a loan’s interest rate, the more money that you stand to make. Not so obvious is the fact that higher interest rates mean a higher risk of default.

Keep that in mind when you choose which loans you’d like to add to your Portfolio.

4. You Can Lose Your Money

Investing in peer to peer lending is like investing in anything. There is the opportunity to make money and the possibility to lose it.

Many people get so caught up in the hype surrounding peer to peer lending that they forget the risk associated with investing. A single dip in the economy and those people’s money could disappear without a backup plan in place.

Don’t be one of the people who put their head in the sand when it comes to the realities of investing.

Know the risks. Invest smart. Never invest what you can’t afford to lose.

If you live by those tenants, you’ll give yourself the best chance of staying protected.

5. Peer to Peer Loan Diversification Curbs Risk

Diversification curbs the risk of peer to peer lending portfolios. While diversification in the stock market is straight-forward (owning stocks in food, transportation, hospitality, etc.) diversification with loans might seem less intuitive.

As a general rule, when diversifying your peer to peer loans, start by diversifying your interest rates. Having a good number of high rates and low rates should keep your portfolio balanced.

Next, look at a loan’s purpose. Is a loan being requested to fund a business venture? Is a loan you’re considering for refinancing medical bills?

Having loans that cover an array of purposes can further insulate you from losses.

6. Fees Are a Possibility

Peer to peer loan companies have to make money to keep providing you with great service.

How do they make their money? In a variety of ways…

For starters, some companies will share in the interest payments that a borrower makes on their loan. Another popular means of making money is by charging borrowers and investors fees.

Before you invest with a company, look through their fee schedule to ensure that you’re okay with what they’re charging. If you’re not, compare their fees to other companies and invest with an organization that’s reputable and less aggressive in excess charges.

7. There May Be Better Investment Options

Just because peer to peer investing is a popular means of making money online doesn’t mean that it’s your best investment option.

Many people see returns from peer to peer investments between 5% and 8%. That’s below the return that you’d likely get from investing in a relatively secure stock market index fund.

As another example, some savings accounts offer 100% secure returns of 2.3%+. Given their no-risk nature, that might be a more attractive investment for you.

Bottom line: Know your options and place your money in an investment that balances risk and reward to your liking.

8. Peer to Peer Lending Is New

Peer to Peer lending has taken off in the last decade. This method is one of the newest investment vehicles on the planet.

While this may make this means of investing attractive, it also makes it unstable.

Nobody knows how peer to peer lending would fair during a serious recession. We also don’t know how future regulations might affect investors.

All of that uncertainty creates conditions that make your money less safe than when placed in tried-and-true investment vehicles like stocks.

9. It Takes Time to Learn How to Invest Effectively

As with any investment, investing in peer to peer lending is a skill that one builds.

You will not hop onto a platform and automatically know exactly how to best place your money right away. You’re also not going to assess risk brilliantly or know when it’s time to cut your losses on a losing investment.

To make sure you give yourself room to make mistakes, start investing small amounts on peer to peer platforms. As you start to see how things work, you can invest larger sums.

A great way to build confidence as a peer to peer investor faster is to work with lending club investing advisors that can help shape your strategy.

10. There Is a Lot of Money Making Potential in Peer to Peer Lending

We appreciate that we’ve hit you with a lot of red flags with investing in peer to peer lending. Just so you know, we haven’t done that to dissuade you.

We’ve presented you with investment risks because we believe that any investment that’s done correctly is one that’s supported by all available information, both positive and negative.

So, to close out our investing in peer to peer lending advise, let us share this last positive tidbit with you… Investing in peer to peer lending has made plenty of people rich and you might enjoy those same results.

Your success on peer to peer platforms will be directly contingent on how willing you are to learn and your discipline as an investor.

Our Final Thoughts on Investing in Peer to Peer Lending

Investing in peer to peer lending has introduced a new class of people to the wonderful world of collecting interest. We hope that your excitement towards this trailblazing means of lending translates into you building wealth and living your best life.

If you’d like more information on lending strategies and more, consider diving deeper into the finance-focused content on our blog.