What do P2P platforms do?
P2P platforms aim to remove banks and finance companies from the intermediation process by directly connecting borrowers and lenders and charging a small fee for their service. Banks borrow money from depositors and lend it to individual and corporate borrowers while ensuring that if the borrower doesn’t pay then the loss will be borne by the bank and not by the depositor. This assumption of risk is directly done by lender on P2P platform whereby if borrowers do not repay loans taken then the individual lender i.e. you will suffer the loss.
Risks in P2P lending
P2P platforms offer individuals a chance to earn high interest raotes by spreading their lending over a pool of borrowers. Theoretically whenever loans are spread over a pool of borrowers, the chances of default and loss are reduced as it is unlikely that all the borrowers will stop making payments at the same time.
Only things don’t necessarily work in real life the way they do in theoretical models. This was the reason for the entire mortgage securities crisis in the United States in 2008. So, if your P2P platform has lent money to a large number of borrowers without sufficient due diligence, then spreading loans over even a large population will not reduce risk. In humorous terms, if you have one sick cow, the chances of it dying are high. If you get 100 sick cows together and form a pool, the chances of many of them dying still remain high.
Remember, a borrower will approach a P2P platform and be willing to pay a high rate of interest only if he is ineligible to get a cheaper loan from a bank or a Non Banking Finance Company.
Should you lend on P2P platforms?
Lending on P2P platforms can be a good way to earn higher returns on your money provided you take care of the following:
- Understand the type of borrowers to whom the P2P arranges lending. You want to avoid NiNJA loans i.e. loans to people with No Income, No Jobs and No Assets. Remember pooling 100 sick cows will get you 90 dead cows, the risk doesn’t go away.
- Look at the number of years the P2P has been in operation. It should have a track record of at least 2 years.
- Ask for typical loss rates for loans given on the platform. If possible insist on getting some commitment or details of loss rates in writing.
- Do a simple mathematical calculation, if you are getting 20% interest per annum on your funding of Rs. 50,000 then what is the amount you could lose if things go wrong. In this case, it will be around Rs. 20,000 if 50% of your borrowers don’t pay back i.e. 5000 interest earned from good borrowers less: 25,000 loss on principal.
- Check the back ground of promoters, they should have strong banking or finance experience and not only technology skills as you are essentially acting as a bank when you use P2P platforms.
Tax and other implications
Interest on P2P
P2P lending is like any other investment made and therefore interest earned on the same needs to be offered to income tax in the efiling of return for each year. The lender will provide statement of interest earned which can be used to complete the return. Unlike savings bank interest, deduction under Section 80 TTA is not available for interest from P2P lending for your income tax return in India.
Principal lent that is not recovered
What happens when the borrowers you have lent to do not fully repay the loan amount. In this case, you will need to carefully consider if the amount not recovered can be said to be a loss (write off) and be taken as deduction in your tax return from the interest earned. Deduction for loan principal is available under Income Tax provided the same is written off as non-recoverable. A document from your P2P lender will be needed to justify that this amount is indeed not recoverable and can be claimed. This document will need to be produced to the Income Tax officer if asked.
#P2P lending #incometaxreturn
Some active P2P platforms in India are i2ifunding.com, lendenclub.com.