The concept of peer to peer lending originated in the U.S. It then made it’s way over to the UK and then eventually Australasia. The process involves borrowing money outside of the conventional methods of using a bank, building society, or credit union. This form of lending is most commonly used by individuals or small-medium sized businesses that need a personal or business loan. Imagine an exchange or intermediary where people are looking to ‘invest’ in others that are looking for a ‘loan’. The other renowned term used is ‘marketplace lending’ because the platforms which are utilised operate under an online website to match investors with borrowers.
For both the investors and borrowers, a number of factors need to be taken into account before using this type of product. When investing, the suitor will be buying a financial product, also referred to as a managed investment product. Whilst borrowers are essentially borrowing money from the investor that is to be repaid over time. The platform promotes both a service to borrowers and investors and makes a commission by charging fees to both parties. Where the bigger banks have more overheads, the nimbler and alternative peer to peer platforms can offer borrowers more competitive rates, which are then paid back over an agreed time period.
Investors can be interested in this type of lending because they are presented with a range of interest rates for their potential investment. Borrowers may choose to apply for a loan using such a network because it may offer loans with a lower level of interest than a traditional bank or personal loan might offer. The rates may vary depending on the platform, however its very important to research all the different platforms to understand how they work.
Linking investors with borrowers
Some marketplaces in Australia offer a hybrid model, so lenders might not be matched directly with a consumer, but invest in a collection of consumer loans. The investor decides how much they would like to invest and how it will be used. To break it down, an investor may be able to choose to fund a single borrower or be able to invest in a portfolio of loans. Additionally, investors might have the option to choose the lowest available interest rate that the platform is offering.
Ongoing repayments from borrowers are collected via the network and deposited to the investors throughout the agreement. The investor’s money can either be returned as part of the repayments or at the end of the loan term. When a borrower applies for a loan, the network will assess their affordability and eligibility by evaluating their credit rating. Not all platforms disclose the lending risk of each borrower and personal details are kept confidential at all times.
Things to consider
Peer to peer platforms are formed as managed investment schemes. This means the platform must possess an Australian Financial Service Licence (AFSL), which allows them to run the scheme and comply with the national regulator ASIC. The platform should have the details of the scheme of the registration and ASFL on their website and the details of its Australian Credit Licence (ACL).
Always remember to pay attention to the below:
- Loan type – is the loan secured or unsecured?
- Interest rate – how is the interest rate calculated?
- Loan options – can you choose loans or borrowers. Can you invest in more than a loan?
- Repayments – how long will it take you to pay off your loan?
- Money back – are you able to reclaim your investment should you change your mind within a certain time period?
- What happens if the borrower defaults – what security does the platform provider and who covers the cost of reclaiming the money?
- Fees – are there any additional fees charged by the platform such as handling repayments or withdrawing money early?
Bear in mind, the platform being operated by the company doesn’t lend its own money, so all of the risks is in the hands of the investor. This means as an investor, there is the prospect of losing some if not all of your money, should the borrower not repay their loan. This risk is mitigated in the comparatively high returns you are likely to receive for your investment. As with any investment, there are no guarantees on getting your money back, even if you opted for a low-risk loan.
Operating networks will make claims on the borrower’s ability to repay the loan and grade borrowers by their level of solvency. It’s always sensible to bear in mind that ratings are based on the current data risk assessments which are not directly linked to the data used by a credit bureau. Nor are they correlated to ratings used by other peers to peer lenders.
Before you sign up with a peer to peer network, you should always read the information available on their website and in particular the terms and conditions of the agreement. Always look at the rates available in the market and shop around. You might find a better option to suit your needs with a traditional lender.