While still relatively small, peer to peer lending, otherwise known as P2P lending or marketplace loans, is a growing part of the global financial landscape.
Still in its relative infancy in Australia, the local market for peer to peer consumer loans has already grown from US$2 million in 2013 to US$158 million in 20161.
We explain what peer to peer lending is, how it works and the benefits and risks for both borrowers and investors.
What exactly is it and how does it work?
Peer to peer lending is a way of borrowing money without going through a traditional lender, such as a bank, building society or credit union.
It operates through online peer to peer lending providers, who match people or companies who have money to invest, with people or companies who are looking for a loan.
When borrowers apply for a loan, the provider will evaluate their suitability by checking their credit history and capacity to repay the loan, and, if approved, the interest rate they are charged is based on their personal circumstances2.
Lenders decide how much money they want to invest, typically via a managed investment fund, but how much control they have over who their money is loaned to, for how long and at what interest rate varies between peer to peer providers3.
Benefits and risks for borrowers
Most loans from peer to peer providers are used to consolidate other debts, for purchases such as cars, or to fund large expenses such as renovations, weddings, education or a holiday.
The main benefit for borrowers is that the interest rate offered may be lower than what’s available from a traditional lender, especially if you’re identified as a good credit risk, as each risk is assessed based on individual circumstances4.
Peer to peer providers also offer fast loan approvals and typically do not charge fees for early repayment.
The main risk for borrowers is what would happen if the peer to peer provider became insolvent. As with any financial product, it is important to read the product disclosure statement and terms and conditions to ensure you fully understand the risks involved.
Benefits and risks for investors
The main benefit for investors supplying capital for peer to peer lending is the opportunity for higher returns than they may be able to achieve with other investments such as savings accounts or term deposits. However, with higher returns usually comes a higher level of risk.
It’s important to understand how your money will be used as this can vary between operators – for example, will you be funding 100% of one loan, or will your money be spread across a portfolio of loans?
The amount a lender knows about a borrower varies between providers, but ultimately, they are trusting the provider to make an accurate assessment of the credit risk associated with each borrower.
The product disclosure statement should explain how borrowers are assessed, and to find out how good the peer to peer lender is at making this assessment, investors should request information about the provider’s default and late payment rates.
The main risks faced by investors in peer to peer lending is what happens to their money should the borrower be late making payments or default on a loan, or should the provider become insolvent.
Peer to peer lenders are not included in the government’s Financial Claims Scheme, where bank savings and term deposits for amounts of up to $250,000 are guaranteed by the government should a bank, building society or credit union fail.
Some peer to peer lending providers have a compensation fund to assist investors who suffer losses, which is funded by a fee charged to borrowers. However, such compensation funds don’t guarantee that any losses will be fully covered. Investors should check what debt recovery plans the provider has in place and also who pays for these.
For more information
As with any financial decision, it’s worth doing your research, so visit the Australian Securities and Investments Commission (ASIC) website to learn more about the regulation of peer to peer lending in Australia.
And for more information on debt consolidation or investment options, speak to your financial adviser. If you don’t have an adviser but would like to seek some advice, you can call AMP on 131 267 or use our find an adviser tool.
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Investors should expect more volatility in the months ahead, according to Dermot Ryan, AMP Capital Income Equity Fund Co-Portfolio Manager.