Peer-to-peer (P2P) lending provides a platform to match borrowers with investors. By using clever technology, P2P lenders can cut the inefficiencies of traditional lenders. Sometimes, this can result in a more competitive interest rate for borrowers and a competitive return for investors.
Well-established abroad, P2P lending first appeared in Australia in 2012. Since then, it’s has grown in leaps and bounds as an increasing number of Australians use P2P lending for investing and borrowing.
How does P2P investing work?
P2P (or peer-to-peer lending) is an online marketplace, bypassing the traditional credit providers (banks, building societies or credit unions) by directly matching investors, who become the “funders”, and borrowers.
Funding comes from investors, who can be individuals or entities and can be used by borrowers for a variety of reasons, including personal loans, business funding, or property construction or development. Essentially, borrowers sign up to receive loans from a non-traditional source (i.e. not a bank), investors become lenders in order to receive a higher return than what they’d normally get from savings accounts, term deposits and other investments.
How do I choose a P2P lender to invest in?
There are lots of options when it comes to selecting a P2P marketplace. Some focus on smaller value consumer lending, some on larger value business lending. Some P2P lenders offer secured lending while others offer unsecured lending. Essentially, not all P2P lenders are the same – there are lots of variations to suit different needs so it’s worth doing some research to understand the different options available.
But let’s take a step back: what if you’re relatively new to investing in P2P lending? Where do you start? After all, there are several P2P lenders to choose from, so how do you know which one is right for you? Here are the five things you should consider before deciding on a P2P platform.
1. A retail licence
To operate in Australia, P2P platform operators must apply for, and receive, an Australian Financial Services (AFS) licence and an Australian Credit Licence. These licenses are issued by the Australian Securities and Investments Commission (ASIC) to businesses that meet certain thresholds, such as senior management experience and competency requirements; minimum operating capital requirements; and the requirement to perform appropriate credit and affordability assessments. If you’d like to be sure that the P2P organisation you’re planning to invest in has met basic requirements, checking that it holds an AFS licence and an Australian Credit Licence is essential.
2. Protection for your investment
Because P2P operators are not banks or credit unions, your investment (in a portfolio of loans) is not guaranteed by the Australian government (as would be the case if you made a deposit with an authorised deposit-taking institution, up to a certain amount). However, that doesn’t mean P2P operators haven’t come up with novel ways to minimise the chances that you will lose your investment. For example, some P2P platforms charge a risk-based fee to borrowers, which is a separate pool of funds, sometimes known as a provision fund. The provision fund is designed to help protect investors in the event that a borrower misses a payment or defaults on their loan. Although, a provision fund is not a guarantee that you will be compensated.
3. A commitment to comprehensive credit reporting
Comprehensive Credit Reporting (CCR) or what is sometimes referred to as ‘positive reporting’ allows credit reporting bodies to hold and acquire positive credit information on client credit histories. CCR not only provides borrowers with an opportunity to rehabilitate poor credit scores or improve strong ones; it also allows lenders to perform a more detailed assessment of prospective borrowers. This can result in more personalised rates for borrowers that reflect their risk profile.
Related articles: Peer-to-Peer Lending Checklist
4. Evidence of ongoing transparency
In an effort to draw attention to their performance, and distinguish themselves from traditional lending institutions, many P2P operators have voluntarily made their loan books publicly available.
This commitment to transparency means that investors can review the organisation’s borrowing requirements, leadership credentials, past financial performance, default rate and also research what sort of loans are commonly funded (such as debt consolidation or renewable energy loans). If you’re trying to choose a P2P lender to invest with, finding one that’s committed to openness and transparency is a great way to start.
5. Positive customer reviews
Before settling on a P2P platform operator, it’s also worth doing some research into what past investors say about their experience with the business. How has the operator fared on a review website? Has it received any awards for value or service? If you’re going to be investing through an online platform, it’s important to ensure that you’ll be able to access excellent customer service and helpful guides if you ever have any questions.
What are the biggest risks associated with P2P investing?
The biggest risk for P2P investors is the borrower defaulting or repaying the loan late. If a loan cannot be repaid by the borrower, you may be limited by what you can recover from your investment, depending on the loan type. There is also interest rate risk to consider, which is the same for any fixed term loan – there could be some risk of interest rates rising before the term has finished which means you can’t move your investment into a higher interest loan.
Keep in mind that investing in P2P lending is not for everyone. Before you dive on in, make sure that you thoroughly research what’s entailed.
