Peer-to-peer (P2P) lending: yes, it sounds like BitTorrent for banks, because it kind of is. But if you were that kid — the one who took games of Monopoly a little too seriously — you will love this concept. And if you just think banks should give people a fair go and cheaper credit you'll love it too.
Money picture from Shutterstock
What Is P2P Lending?
P2P lending is the brave new world of financial services, deftly removing the middleman (ihat is, the bank) from the lender/borrower equation. Through online platforms such as SocietyOne, a growing community of DIY lenders are directly funding personal loans to everyday Australians looking for an alternative to overpriced bank-funded personal loans.
Looking for a cheaper personal loan? Or ever considered how cool it would be to be your own bank - vetting clients, undercutting the competition and lending money to earn interest well above 10 per cent? The fledgling world of P2P lending promises all this and more, but like any investment class, it comes with risk.
P2P lending is still a pretty new concept in Australia and like any investment class you need to know what you're getting yourself into. As a lender you get to be the bank, in real life, undercutting the competition by lending your savings to people and making more money than you could possibly make in a normal high interest account. As a borrower it potentially means a better deal on personal loans and the opportunity to be rewarded for a good credit rating with massive discounts.
However, for lenders especially, if things don't go to plan, you could lose it all.
Why P2P Has Promise
In an ideal world, P2P offers would-be borrowers and cashed up investors a pretty compelling win-win. Borrowers (especially those with good credit ratings) can find highly competitive rates compared to those offered by the banks, along with an easy, friendly online or mobile experience. Meanwhile, cashed up investors have the opportunity to tap directly into one of the most profitable spheres of banking, access a lucrative new asset class and earn more interest on their cash savings than they could just about anywhere else.
Although still in its early days in Australia, P2P is a powerful idea for banking customers, promising more affordable loans and giving established lenders a clear message that the sky-high rates on personal loans just aren't cutting it.
In the world of personal loans, major lenders have a habit of tarring all borrowers with the same brush, treating AA rated borrowers exactly the same as those at the highest risk of defaulting.
P2P lenders have the ability to be a lot more dynamic in their approach so the rates for low risk borrowers with a sparkling clean credit record can work out to be highly competitive. If P2P lending manages to 'spook' banks enough to drop their rates that would be a gift in itself.
There's no doubt that personal loans are a lucrative asset class. The promise of 10 per cent or more fixed interest is enough to turn most savvy investor's heads, but before diving in, make sure you know the risks. And lenders should be cautious: the risk is all yours.
For investors interested in P2P lending, it's vital to understand the risk you're taking on. Unlike earning interest on cash in the bank, personal lending isn't covered by the government guarantee. So, if your debtor falls into the small percentage of borrowers (approximately 2.8 per cent) who do default, you are personally liable for the loss.
Remember! The higher the interest rate they're prepared to pay, the higher the risk. The old adage rings true here, that if the returns sound too good to be true, they probably are.
As with any investment be sure to do your research, vet your client and make sure you understand:
- What the loan is being taken for;
- The timeline for repayments;
- Whether your borrower can realistically service the loan.
Lenders are also advised to diversify by spreading their risk across multiple loans and protecting themselves by keeping the body of their wealth in less unusual asset classes.
Although 'being the bank' has a certain ring to it if things go pear shaped, the risk is all yours. So, investing your whole nest egg in 22-year-old-Michelle-from-Perth's-dream-wedding-fund might not be the wisest investment move you could ever make.
P2P lending also presents a risk for borrowers who may use a cheaper line of credit as an excuse to take on more debt than they should. If you're disciplined about it P2P can be a fantastic source of affordable credit, but a cheaper loan doesn't mean you should borrow more.
Borrowers also shouldn't assume that P2P is always going to give them the cheapest option. Loan seekers should still take a few minutes to compare any P2P loan quote they get with a full list of personal loans available from other providers, just to make sure the deal is as sweet as you think it is.
Potential lenders should be stringent about the kinds of loans they fund. The world of P2P is still extremely new and regulation is still in the works. In the meantime if you're keen to give P2P a go, keep in mind that not all platforms are made equal and each will have different standards for vetting borrowers.
There's a seed of truth to the Shakespearean adage "neither a borrower nor a lender be" — no one wants to wind up a Shylock demanding his pound of flesh from a debtor who can't pay. However, in a world where the banks are making up the rules as they go along, taking banking personally might be just what it takes to get the fat cats running scared.
Kerry Lotzof is a personal finance expert and writer, covering lifestyle and finance topics for Mozo.com.au, Australia's money saving zone.