Modules for Investors
Alternate investment options in India outside of pureplay financial instruments
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Investing in the future: P2P lending and merchant lending
What is peer to peer lending?
Have you ever lent money to another individual for a short period of time? If you have, then what you’ve just done is be a part of peer to peer lending.
Peer to peer lending, also known as P2P lending, social lending, and crowd lending, is essentially a form of an informal lending activity. Here, individuals approach other individuals for funds instead of financial entities such as banks and NBFCs.
Although it might sound rudimentary, modern peer to peer lending is anything but that. In fact, there are dedicated P2P lending websites that connect individuals that wish to lend their money to others who wish to borrow. And despite being an informal way to gain access to funding, some peer to peer lenders often look for borrowers with good credit score and history and strong ability to repay the loan.
How does P2P lending work?
So, how does peer to peer lending actually work? Let’s take a brief look at this concept.
Traditionally, individuals who required access to funding had to approach banks or other financial institutions. However, since the eligibility criteria for loans generally tend to be quite stringent with financial institutions, individuals with low credit scores or poor credit histories have a hard time getting access to funds.
This gave rise to peer to peer lending, where individuals who have not been able to gain access to funds through the traditional way could request other individuals to lend them the money that they require through dedicated P2P lending platforms.
Similarly, individuals with surplus funds who are looking to earn a slightly higher rate of interest on their investments, albeit with slightly higher risk, could also choose to lend to another individual through a dedicated P2P lending platform.
If both the borrower and the lender are able to accept the terms laid out by each other, the funds are exchanged. And as per the terms laid out by the lender, the borrower would then have to start repaying the loan by making monthly payments to the lender.
What are the advantages if you become a P2P lender?
If you’re planning to start lending through a peer to peer lending platform, knowing what’s in store is key. So, here are the advantages that you get to enjoy by becoming a P2P lender.
High return on investments
Most of the borrowers on P2P lending platforms lack the means to gain access to funds through the traditional way. This could be due to them possessing low credit scores, lack of their ability to put up a collateral, or little to no credit history. Since P2P lenders often overlook or pay little attention to these factors, they charge a high rate of interest to cover the increased amount of risk that they take by lending to such individuals.
The rate of interest that you get to earn by becoming a P2P lender is almost always much higher than most other traditional forms of investments such as fixed deposits and bonds. This gives you a chance to earn an excellent return on your investment.
Ability to choose the level of risk
Almost all P2P lending platforms assign borrowers a risk category or a grade. When you’re looking to lend to individuals through the platform, you have the freedom to browse through the various risk categories and choose the level of risk that you’re willing to take. Generally, the higher the risk you’re willing to take, the greater your chances are at earning a high return on your investment.
Protection from default
Although peer to peer lending is often highly risky, many lending platforms have systems in place to protect the lenders from default. For instance, if a borrower defaults on a loan, the P2P platform may compensate the lender for their loss via contingency funds that the platform maintains for events such as these.
What is merchant lending?
Merchant lending is a unique form of financing that can be availed by small businesses and merchants with a Point of Sale (POS) system.
Also known as merchant loan advancing, the lender usually provides the borrowing merchant with a cash advance. The lender then automatically collects the loan from the borrower by taking a percentage of the sales that the merchant makes through their Point of Sale (POS) system (debit card and credit card sales) each day. The merchant lender continues to do this daily till the entire loan along with the interest is repaid.
Merchants with a POS system looking for funds to purchase goods that they would be later selling, can make use of merchant financing for their cash needs. Similarly, lenders who wish to provide merchant lending services can also do so by setting up a dedicated merchant lending business since carrying out the activity may not always be possible as an individual.
Features of merchant financing
Now that you know what merchant financing is, here are some of its key features that you need to be aware of.
- The amount of loan that merchants get to avail is determined based on the value of transactions made through their Point of Sale (POS) system.
- Depending on the daily sales made through the POS system, merchants can avail cash advances even to the tune of Rs. 1 crore.
- The tenure of the loan usually ranges anywhere between 6 months to a year.
- Merchant financing is usually quick and is approved within just a few days.
- The interest rates applicable on merchant financing usually tend to be higher than other traditional forms of funding.
So, there you have it. With this, you must now be aware of the concepts of P2P lending and merchant lending. In the next chapter, we’ll take a look at art and antiques.
A quick recap
- Peer to peer lending, also known as P2P lending, social lending, and crowd lending, is essentially a form of an informal lending activity.
- Here, individuals approach other individuals for funds instead of financial entities such as banks and NBFCs.
- The upsides of P2P lending include high return on investments, the freedom to choose the level of risk and a certain degree of protection from default.
- Merchant lending is a unique form of financing that can be availed by small businesses and merchants with a Point of Sale (POS) system.
- Merchants with a POS system looking for funds to purchase goods that they would be later selling, can make use of merchant financing for their cash needs.
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