Savings rates are depressing. The stock market is gloomy and volatile. But, there is another option to get better returns on idle cash.

The bank is paying pennies in interest on your cash savings because the Federal Reserve is keeping rates low. On Wall Street, the roller coaster ride of daily market swings is too much to stomach.

Where else can you look to make your money grow?

For those who are willing to take on risk without the ups and downs of the stock market, the growing niche of peer-to-peer (P2P) lending is making a name for itself.

P2P Lending 101

In the realm of finance, lending money to another person is not considered a good idea.

Either lend with the expectation of never getting any money back or look forward to broken relationships when repayment becomes nonexistent.

With the introduction of the young P2P lending market, dominated by Lending Club and Prosper, investors can lend money to complete strangers with the formalities that come with institutional lending – and earn interest just like banks.

Through a regular taxable account, 401(k), or IRA, investors can scour pages of listings where borrowers make requests for loans for a plethora of reasons including debt consolidation, home improvement, weddings, and small business start-ups.

Borrowers are required to disclose their rent/mortgage situation, location, and income. Investors have access to the borrowers’ credit histories to evaluate borrowing behavior. Follow up questions can be presented so investors can better assess the financial situation and habits of borrowers.

Give Me Returns

Managing risk and rewards is a major part of investing. With P2P lending, there is always the possibility of a borrower defaulting, regardless of an impeccable financial background.

Typical to the credit markets, higher credit scores mean lower consumer interest rates. Investors who are willing to bet on borrowers with low credit scores have the opportunity to earn higher returns.

Because investors can invest in P2P loans with as little as $25 per note, there is plenty of room for diversification across many borrowers.

According to Lending Club, 100% of investors with 800 notes or more purchased from Lending Club have experienced positive returns – 91% are earning 6%-18% returns.

At Lending Club, an “A1” grade loan with borrowers touting credit scores higher than 750 are considered the safest of the bunch. These A1 loans dole out a 6.03% return for investors.

Online savings accounts are struggling to hold on to a 1.00% APY and 5-Year CD rates are far from the 3.00% APY that was available earlier in the year. The Fed also shared sad news that rates will stay low into 2013. World-renowned billionaire investor Warren Buffett expects the entire stock market to return 7% going forward.

P2P lending may be relatively young and we don’t know where this investment sector is going. For now, it looks attractive to people who are not satisfied with the yields from stores cash and not comfortable with the current investing climate.

As a small Lending Club investor, I’ve found that P2P lending certainly shows promise. Additionally, it offers a boost to one’s conscience that I’m help out someone in need while also being rewarded for doing so.

But, the better returns from P2P lending hasn’t kept me from keeping money at the bank or in the stock market – it is simply one more way to grow my money.

If you have tried P2P lending, what’s your take on this type of investing (especially in the current economy)?

Follow Simon in the Community and on Twitter: @simonzhen.

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  • Good article Simon. I have been a Lending Club investor for over two years and a (the other big player in the US market) for one year. I am delighted with the returns I been receiving. If you are after fixed interest and have some tolerance for risk then I think p2p lending is the best risk/reward investment available today. Full disclosure, I publish a blog on the subject, so I am somewhat biased.

    Like you I still have the bulk of my money in traditional investments like the stock market, but I am slowly increasing my investments in p2p lending. One question for you. You mentioned you have a small investment in Lending Club – are you planning on adding to that any time soon? If not, why not? Be interested to hear your reasoning.

    • Simon Zhen

      Yes, low savings rates and a wobbly stock market is driving me to place a greater focus in alternative investments. Going forward, I hope to be slowly adding (not more than $50/month) to my Lending Club account.

      I prefer a rather conservative approach – usually not venturing far past B grade loans.