I was chatting with a friend of mine over the weekend who has just inherited a small amount from her grandfather’s estate. She knew about my involvement in peer to peer lending and asked me if it was a good place for this money. Of course, I told her it was a great idea.

Then she asked me what the risks were and I rattled off a few of the points I mentioned below. But after our conversation I realized that I had never done a post detailing the risks of p2p lending and it is most likely one of the first questions potential investors will ask. So here it is.

The prospectuses of both Prosper and Lending Club go into great detail (over 20 pages each) about the potential risks of p2p lending. While I encourage everyone to read these prospectuses I realize that few people will take the time. So, here are the five main risks as I see them:

1. Borrower Defaults

When you invest in borrower loans these are unsecured loans, meaning there are no assets backing the loans (such as a house in a mortgage loan). So, if a borrower defaults on the loan there is little an investor can do. You just take the loss of whatever amount of principal is left unpaid. With p2p lending default rates averaging around 3% a year, most investors will encounter defaults at some point. [Read more…]