The following is a guest post from Financial Samurai reader, Jeremy Johnson about earning 10% returns in passive income with P2P lending. Jeremy was kind enough to help me out with a random WordPress question issue when I first started back in 2009.
Peer to peer lending is one of the most simple and effective ways I’ve ever found to make passive income. It has outperformed my stock picks, selling old baseball cards, my own business ideas – everything.
I’ve earned more money through it than I’ve earned at anything else except my day job. This is pretty powerful for me. I’ll share a walkthrough of how this works for me and you can use/adjust for yourself.
At the end of this post, I’ll highlight my favorite passive income source that is even better than P2P lending.
Prerequisites To P2P Lending
There’s some qualifications to use peer-to-peer lending such as being in a state that allows it, and having a certain level of verified income in different states. Usually it’s $70,000 a year or more in income.
My state, Utah, has no such requirement. I think most readers of Sam’s website will make the income cut – you’ll just have to live in a state that allows you to invest. Beyond that, you just need a bank account of some kind – online, credit union, etc…, it doesn’t matter what kind of account it is.
Getting Started With P2P Lending
I was most interested in how I could use Prosper.com and spend as little time as possible on the site. Hey, I’m lazy and I like things to be automated. When I started over 2 years ago, only Prosper.com had automated investing. Lending Club hadn’t joined the band wagon yet, but now it has.
When I saw automated investing on Prosper.com, I was immediately hooked. I dumped $10,000 in and input my first set of criteria and Prosper.com picked the notes for me to invest in while I slept. It was great.
How Do You Earn Money?
Prosper.com is essentially a crowd lending website where you become someone who loans out money and you get paid interest. Isn’t that cool? You’re like a bank now, getting paid interest. It’s an awesome feeling to be the lender instead of the borrower. You invest in portions of loans.
If someone on Prosper.com is asking for a $10,000 loan to consolidate their credit card debt, you’ll more than likely not invest nearly that much. You’ll invest in part of the loan – maybe $25, $50, or $100. This is called a note. Lots of people will help this person get that $10,000 loan.
And that group of people will then be the lenders of that $10,000 and when that happens, the loan will be funded and interest payments will begin. When it comes time for the borrower to pay interest each month, you’ll get a portion of that interest.
Can You Lose Money In P2P Lending?
Yes, you can lose money. Like any loan, the person who got the loan could get sick, hurt, have bad luck, be irresponsible, or just plain decide not to pay anymore. If this happens, it is called a default.
Prosper.com will try and get that person into collections, but more than likely, the only money you’ll get is what has already been paid in interest. The rest would be a loss to you.
Fortunately, at this time, far more people are making their monthly payments than are defaulting, but who knows, this could change in the future.
How Do I Get 10% Returns With Prosper?
The way I get 10% is very simple. I use the automated quick invest feature of Prosper.com. I have three categories: Low Risk, Medium Risk, and High Risk. Each loan in Prosper is assigned a rating, from A to E.
There’s also a High Risk category, but I won’t get into that. A’s are the least risky – people with great credit and other things going for them, and E’s are the most risky. However, the E’s pay the most interest back to you and the A’s the least, so there is that to consider when looking at what notes to get. Most of my notes are $50, with some being $25 and others $100.
P2P Lending Loan Choosing Strategy
My strategy to start was to get A, B, and C loans in an equal amount. Prosper.com tells you the average returns for their notes. However, I like to look at my account and see what each loan category is returning. Each month I look to see what note letter returns the most. I then set my automated loans to invest in those.
My High Risk category is D and E loans only. Medium Risk is B and C, and the Low Risk is A and B. This means I can toggle where my interest goes quickly if one note category is outperforming another. Right now, the high risk notes are returning the most, but that could change as I invest more into them.
As a side note, Prosper.com takes a small percentage of the interest (around 3%) earned on each loan – that’s how they make their money. So if you are paid interest on a note for $1.00, Prosper.com will take $.03 and you will be left with $0.97. Not too bad at all.
As a side note comparison, App developers on the Apple store get charged a 30% fee on every transaction where they earn money. Therefore, I consider 3% very generous. I came up with 3% after looking at my interest payments and seeing the Prosper.com service fee and just doing a percent calculation of that based on the interest paid.
P2P Lending Performance
The key values here are my account value, which is $38,259.11 and my annualized return, which is 10.58%. This is the best return I’ve ever had in investing. As time goes on, I’m going to try and maintain this return by investing in notes that return higher than 10%.
Right now, that is C, D, E, and HR loans. As my account balance grows, I believe I’ll have to change from investing $50 per note to more like $100 in order to continue to get notes with my extra cash, but time will tell on that.
Here are my portfolio details:
I’ve got 910 notes and quite a high level of diversification across notes. I’m sure I could do better at screening notes, but my philosophy is to just go where the returns are and invest in those notes. I care about my time, so spending time screening each note or loan is not something I’m interested in doing at this time.
I have a 5% rate of notes being late right now if you count all late notes. Just over 3% of my notes have defaulted and been charged off. I imagine that number will continue to go up as I invest in more notes.
Prosper.com makes it very easy to see how much money and % interest you are earning on your account. You can link your bank account and setup up automatic payments to Prosper.com every month as well and have that money get invested immediately.
If you ever need to withdraw, just turn off automated investing for a time, collect some interest, make a transfer to your bank account, then turn that automated investing back on. To do that, just uncheck your automated investments on the automated quick invest page.
P2P Lending Monthly Statements
Prosper.com will also send you a monthly statement showing you how much interest you earned that month. This is extremely helpful to gauge your passive income per month potential.
My last statement was for December 2020, and the interest was nearly $400. This amount will vary depending on how many notes default that month. But I’m pretty happy with nearly $400 for only an hour of work or less for that month!
The reason for the high cash balance is I dumped an extra $3,000 into Prosper.com for that month and it hadn’t been automated to new loans yet.
Downsides To P2P Lending
You’ll have a tax form to use when you file your taxes each year, so it’s some extra work on your taxes. In addition to that, like anything, you could have a ton of people default on their loans and lose money. You can mitigate this by diversifying your loans. These are the only downsides I see. I’m earning over 10% and love it so far.
P2P Lending Conclusion
It has been over two years now and Prosper.com has outperformed all my other investment attempts. I’m sure I could do even better with my investing at Prosper.com, however, I’m happy with a 10% return or more that only takes me about an hour per month to manage.
Right now, it’s like I’m earning about $300-400 a month interest per hour (for 1 hour) and that amount will continue to rise for that hour of work. It’s like I’m raising my hourly rate; that’s the way I look at it.
If you can take a few hours and sign-up for an online account, get some money transferred, and invest in over 100 loans in a diversified way, you have a good chance to make returns.
– Jeremy
Update 2022 On Passive Income Investments
My favorite type of passive income investment for 2022 and beyond is real estate crowdfunding. It’s nice to have a tangible asset that generates income.
The value of real estate and rental income have gone way up because interest rates have come way down. It takes a lot more capital to generate the same amount of risk-adjusted income. Further, we’re all spending a lot more time at home due to the pandemic.
As inflation expectations pick up, you want to own real estate. Inflation whittles down the real cost of a mortgage and boosts the value of your property. Her is my latest passive income streams. Currently, I don’t have any P2P lending passive income due to my interest in real estate.
My favorite two real estate crowdfunding platforms are:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. Investing in a diversified eREIT is the easiest way to gain exposure for most people.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields. They also have potentially higher growth due to job growth and demographic trends. If you like investing in individual deals, CrowdStreet is an excellent platform.
I’ve personally invested $810,000 in real estate crowdfunding since 2016 to diversify my investments. It’s nice to earn income 100% passively as I spend more time taking care of my children.
Both platforms are free to sign up and explore.
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Why can’t I open an account on Prosper in New Jersey? It only allows certain states to invest. Lending Club has stopped taking investment. What alternative investment sites are there for peer-to- peer lending?
I do the same earning over 12% from European platforms and document my progress in my blog
What’s your blog called?
How do you get paid when your a lender? if you get a monthly statement, can you withdrawal the monthly interest you make?
Lets keep this discussion going. I started about three years ago to learn. I started using the secondary market tool in LC, lost some money, however now LC is legal in my state and im investing again. I’ve had no problem finding loans, however im only investing small amounts at a time. Im well diversified. My average return is 6.5% I’m not very risky.
currently using prosper and my account shows annual net return rate of 11.43%
I read each note and select them. The auto invest feature, well I do not like.
Any update on returns from Lending Club or Prosper? I have heard a few people saying charge offs have been going up and returns have gone down?
Is this true in general, or are the majority of people still getting stable returns?
So i have about 85-90k in LC right now and i’m depositing about 1-2.5k a month; everything handled for me automatically by LendingRobot. Any money deposited from payments doesn’t sit in there any longer than the time until the next investment round in the day (~1-3 hours). My goal is to reach a level where my passive income from this is more than my regular income. No specific reason, just because. I’m also fully maxing 401K (up to IRS limit for 401K, not just pre-tax limit) and my wife is doing the same; we also both have pensions in addition to all the investments. We’re also maxing out all other tax advantaged mechanisms (Trad –> Roth conversions, etc.) before people start getting trolly or angry about it.
So…for me LC is just an amazing passive income machine that gets every nickle re-invested AND i’m feeding it even more monthly. Again, this is all after all other fundamental “financial hygiene” is already taken care of.
FWIW, my parents are about to dump about 400-425k from sale of home into it and with very conservative projections have some pretty significant annual passive income within 2-3 years (~100k).
Am i completely out of my mind or missing something here? I get the taxation argument, but all regular income is taxed and i just don’t know of another investment vehicle that is nearly as liquid (I’ve tested and I can automatically dump via Lending Robot massive amounts in just a few days), with nearly the returns (i’m getting ~15% but suspect longer term ~10%), and all passive (again, with 3rd party services which take a small cut).
Waiting for education…(and trolling)
Lending Club just opened up in NJ. I opened an account when I lived with family there for their secondary market, but never used it. Now that I live in a state that doesn’t allow it, what are the risks of investing using the old address that’s still on file with LC?
I have been using Prosper for years but at a smaller scale. I did setup my auto invest criteria and occassionally see the email that says thank you for your auto investment. I am now more interested in how active money really is, and wanted to consider taking a low interest rate loan for 20,000 and dumping that into Prosper to lend out at a higher rate. The numbers would be like 3.5% my borrow, and looking for 6-8% gain in lending, which is roughly managing notes with a 10-12% interest rate. Does this seem like a good concept and eventually when I pay off my investment note, I jump to that 10% range discussed in your article.
I would never borrow money to try to make money, unless you can pay it off outright.
In the end I am wondering who makes actually really solid money here. I thought about it but the risk involved would have me starting rather small and 10% on 2 or 5k is just not worth any hassle whatsoever in my opinion. I can make 2-500 easily in any given year without any other investment other than a little time.
Has anybody been using p2p for a couple of years with $20k+ and what has been your return over the years?
I tend to think we try to validate a concept and once you see positive returns and dump in more money just to find out it is not all that great. Sure, savings account has 0%(well close to it) but I also do not risk X to make 0.10 X in a year if all goes well. Given the regular tax rate applies to these it does even more unappealing than I thought.
10% yearly seems to be viewed as doing good in average, but after factoring in tax, your tied up money etc. how much can you really say you made?
I had the same concern, you made really good points. I was originally planning to throw 5k at this project but it doesn’t seem to worth it with taxes. At least a savings account wont get taxed.
I would rather buy rental properties or invest in real estate crowdfunding (easier). I want a tangible asset with tax advantages.