Looking for a cheaper personal loan? Or ever considered how cool it would be to be your own bank – vetting clients and lending money to earn interest well above 10%? The fledgling world of Peer2Peer (P2P) lending promises all this and more but (for lenders especially) it’s not without risk. Mozo takes a peek inside the brave new world of P2P lending to find out why it has the banks running scared.
What is P2P lending?
P2P lending is the brave new world of financial services, deftly removing the middleman (i.e. the bank) from the lender/borrower equation. Through platforms like 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.
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 online or mobile experience. While, 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 than they could 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 (often in the vicinity of 13%+) 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%+ fixed interest is enough to turn most investors heads, but before diving in make sure you know the risks.
Lenders beware the risk is all yours
For investors who are considering becoming a P2P lender, 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%) 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 and;
- Whether your borrower can realistically service the loan
Lenders are also advised to diversify by spreading their risk across multiple loans and protect themselves by keeping the body of their wealth in less unusual asset classes.
Although ‘being the bank’ has a certain ring to it (monopoly lovers you know who you are!) 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 cheap credit, but a cheaper loan doesn’t mean you should borrow more.
Borrowers also shouldn’t assume that P2P is always the cheapest option. Borrowers should still take a few minutes to compare any P2P loan quote they get with personal loans available from other providers.
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.
For the moment, the only P2P loan provider listed on Mozo is SocietyOne.
Have you had a Peer2Peer lending experience that’s been good, bad or otherwise? Leave us a comment with your experiences below!