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Realities behind creating 'passive' income

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Peer-to-peer lending
Peer-to-peer lending | tazytaz/Getty Images

Peer-to-peer lending

More investors are turning to peer-to-peer, or P2P, lending as a way of creating passive income. And for good reason: According to MarketWatch, annual returns for investors in Lending Club, the largest P2P lender in the U.S. market, average 5% to 9%, depending on the credit grade. But to achieve such returns, you can't be as passive as you might wish.

A P2P loan is a personal loan made between you and a borrower, facilitated through a third-party intermediary such as Prosper.com or LendingClub.com. As a lender, you earn income via interest payments made on the loans, but because the loan is unsecured, you face the risk of default.

To cut that risk, you need to do 2 things: Diversify your lending portfolio by investing smaller amounts over multiple loans (Prosper.com recommends more than 100), and analyze the historical data on the borrowers to make the right picks, says Udo. For example, Udo has found that lending to those borrowing for home-improvement projects brings a lower default rate, as does lending to borrowers who haven't sought loans elsewhere within the prior 6 months.

The time it takes to master the metrics isn't the only reason P2P lending isn't entirely passive. Because you're investing in multiple loans, you need to pay close attention to payments received. "I get about $100 (in interest payments) every week that needs to be reinvested since I want it to accumulate interest," says Udo. "I have to go back every week or two to reinvest. That takes time."

LOAN SEARCH: If you're not ready to invest, you can borrow from a peer-to-peer lender - check out personal loan rates with LoanMatch.

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