Five Investment Prerequisites to P2P Lending
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Before investing money in Prosper or Lending Club Loans, I decided to list several reasons to not invest in P2P loans. Where should I reasonably put my money first – before P2P lending? I am in the process of funding my Lending Club account, so I decided to make a quick check list to determine if P2P lending is the correct choice.
UPDATE: I have made my first Lending Club Investment and collected P2P Lending advice for new lenders from several bloggers.
There are several other investments that one should invest in before P2P lending include an emergency fund, credit card debt payoff, 401K, Roth IRA, and a home. Not all are applicable to every individual’s situation, but I will detail better options where most people should use their money before P2P lending.
Emergency Fund
Do you have an emergency fund to cover three to six months in expenses in liquid assets? I prefer six months. Everyone needs to keep an emergency fund in case of unexpected expenses or loss of income. I do not keep my entire emergency fund in a money market or savings account. I keep a small percentage in a short-term bond index fund and in a total stock market index fund. All these investments are easy to convert to cash in case of emergency. P2P loans are not a liquid form of investment – less liquid even than a home. You currently cannot resell them or borrow against them in an emergency (like you can with a HELOC.) I consider an emergency fund an investment in financial security and peace of mind.
Credit Card Debt
Do you have any credit card debt at an interest rate higher than about 8% (or about to reset to a higher rate)? If so, pay that credit card debt off before you invest in P2P loans. Your credit card can provide an additional emergency cushion but only if it is not maxed out. Why earn 8-14% on a P2P loan, when you are paying 18-22% on a credit card? Even if your interest rate is low on the credit card debt, I would still consider paying of the credit card before P2P lending if the balance is high.
401K Savings Plan
If you are eligible, are you investing in your 401K plan at least to the amount that your company matches? If not, you are likely passing up the biggest return on your investment available. The company where I work has a fantastic, but very unique plan, so I won’t mention the details. I am taking full advantage of it and it is paying off very well. Including h match, I have been able to save 22-30% of my pay annually over the last few years.
Roth IRA
If your income is not so high to prevent you from investing in a Roth IRA, you should first max out your Roth IRA before investing in Prosper or Lending Club. The Roth IRA is a fantastic investment opportunity. You pay no taxes on your capital gains, interest or dividends as long as you take the money out after retirement age. Even better, if you need the money in the event of an emergency, you can withdraw up to the amount you have invested at no penalty. If you think that you might need some of your Roth IRA investment for an emergency fund, remember to invest more of the money in less volatile investments such as bonds. I have not quite met this prerequisite but I will have met it before the deadline to invest in 2007 – April 15th, 2008. Currently, the income limits on Roth IRAs are $114,000 for individuals and $166,000 for married couples.
Primary Residence
If homeownership is right for your situation, do you already own a primary residence? Generally, a home would be a better investment than a Prosper loan. However, I do not believe you should pay off the primary mortgage before investing P2P loans. (Of course this varies by personal situation, location, and interest rate.) Usually, a mortgage is the cheapest interest that you will pay because the interest is tax deductible. Just remember to carefully read the terms of the mortgage so that you do not end up in the same circumstances as many people who borrowed using introductory rates, ARMs, or jumbo payments – foreclosure.
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December 4th, 2007 00:37
[...] potential lenders. First, let me offer my own advice that I wrote on another site I just started - Five Prerequisite Investments to P2P Lending. I listed out the top five places you should put your money before even considering lending with [...]
December 11th, 2007 01:49
[...] Which should you purchase Prosper P2P loans (assuming your skilled enough to earn a 12% return) or the S&P500 which has earned 13% per year over the last 20 years? The answer is not simple and it depends greatly on taxes. I will provide you with a spreadsheet to evaluate your own personal situation and propose a whole new class of currently non-existent investment with supercharged returns. This post on tax efficiency is written as a follow up to the discussion on Lazy Man and Money related to Prosper Loans who posted in reference to Free Money Finance’s Criticism of Prosper as an investment. Personally, I have a laundry list of prerequisites to P2P lending. [...]
December 14th, 2007 22:51
[...] is not the best investment due to income tax on P2P loan interest and I believe that there is a better list of prerequisite investments. However, Lending Club is paying out an incredible Return on Investment Bonus that may shift the [...]
December 15th, 2007 01:52
Thanks for the link to your site over on Lazy Man. It seems there are better places to put ones money, before the P2P, then there is money in an average joe’s pocket book.
Another came to mind while reading your suggestions. Place the money in a high interest savings account to fund a side business.
I’ll subscribe to your site and check back to see how you make out with it though.
Best of luck to you.
December 15th, 2007 23:27
Hi Bob. Thanks for commenting and subscribing. I am going to try to update this site a few times per week because I really do have a lot of useful knowledge on the subject of personal finance. It is something that m parents have hammered on my for years.
There are much better places for most people to put there money. Did you see the post on the income tax implications of P2P loans? That will put it in clear prospective that you should be maxing out all tax deferred investments first and even a non-tax protected S&P 500 investment is a better investment than p2p loans.
I added a blog roll link to Lazy Man and Money since he referred a few visitors to me based on my comments and I appreciate it. He really has a great site that I like reading.
January 4th, 2008 12:15
[...] quite liked Five Investment Prerequisites to P2P Lending since it is very clear that you should be responsible with your asset [...]
January 6th, 2008 12:35
[...] Five Investment Prerequisites to P2P Lending [...]
January 6th, 2008 21:13
[...] Land)Â article at the Official Prosper Blog Digging for Gold around the Portfolios and 2) the prerequisite investments to peer-to-peer lending which includes basics like an emergency fund and your work [...]
January 13th, 2008 23:07
[...] (that I seem to have little time for) I have posted two P2P lending articles including the five prerequisite investments to P2P lending including an emergency fund, 401K, a Roth IRA, etc and I also performed a basic tax impact analysis [...]
March 21st, 2008 00:10
[...] income tax treatment of peer loans reduces your return plus the taxes can be difficult to file. The Roth IRA is a better investment than P2P loans if [...]
June 30th, 2008 07:11
[...] are things that you have not considered, you might want to take a look at this post I wrote on the prerequisite investments to p2p lending. These icons link to social bookmarking sites where readers can share and discover new web [...]
April 27th, 2009 02:55
Once again an excellent written post from you. Keep it up!
October 9th, 2009 07:30
Hi,
you are right, one should pay his/her debt before P2P lending.
Nice Post, keep it up.