Even though peer to peer lending is a great choice for potential borrowers, the benefits versus risk aren’t as clear cut for investor lenders. As a lender, The Lending Club touts an average rate of return of 9.6%, which is exceptional compared to what you could obtain in a money market account or bond fund. Unfortunately, that high rate of return comes with risk attached to it that anyone considering investing should be aware of.

First is the potential that a borrower might default on their loan. If a payment isn’t received from the borrower, no payment is made to the investor. The Lending Club says that they make every effort to collect on defaulted loans and is currently reporting a relatively low default rate of 3%. Unfortunately, since their platform is relatively new, the default rate could increase over time as loans age. Related to default potential is the fact that The Lending Club doesn’t verify income or employment for all loan applicants. A credit report is pulled for each applicant but income is taken at the word of the borrower unless The Lending Club has a reason to verify. Each loan with verified income is shown with an asterick on their website. Nor does The Lending Club monitor what the borrower uses the funds for. If the borrower doesn’t use the money to pay off their credit card debt then the risk of default could be higher.

Due to the risk of default, The Lending Club recommends that potential investors spread their investment across many loans, as many as 100-200 in some cases, depending on the amount invested. In this way, one default will not totally wipe out your investment and your average return will remain relatively high. The Lending Club can help you select a loan portfolio based on specified criteria or you can choose your own loans to fund. Borrower information is transparent, including the intended use of the money, making it easier for potential lenders to choose the loans they’d like to fund.

Another thing potential investors need to keep in mind is that The Lending Club charges a 1% fee on each payment to investors. This is pretty steep but because the interest rates are so high, investors still earn a good return on their investments.

Finally, it’s important to mention that if The Lending Club or Prosper go out of business, you may lose all of your investment. There are contingency plans in place to try to collect on outstanding loans in the case of a company bankruptcy but there’s no guarantee that the investor’s money would be a priority for payment.