If you’ve been following the world of alternative investments, chances are you’ve at least heard of P2P lending. P2P (peer to peer) lending is a relatively new concept — in Australia at least. In the UK and the US, it’s almost a mature industry, generating billions of dollars in returns for investors every year.
But what exactly does it involve? How do investors make money? What are the risks? And who’s doing it in Australia?
Here’s a quick run-down.
PLEASE NOTE: The following summary does not constitute advice or a recommendation. Please seek independent advice before taking up a debt product.
What is P2P lending?
Peer to peer lending is when individuals lend to other individuals via a P2P platform. The platform facilitates the transactions, administrates the applications, and organises the underwriting and insurance. In return, they take a small cut of the profit before it’s returned to the lender. Borrowers can borrow as much as they need, and lenders can lend as much as they can afford. Though usually, the lender’s risk gets split into small units across many different loans. Lenders usually also have a choice of loan terms (with different rates of return attached).
Unlike traditional bank-to-consumer lending, there’s no one standard rate. Borrowers with good credit history can get good rates. Borrowers with a less than perfect record can also get loans, but may have to pay a higher price.
Here, the ABC’s The Checkout explains the structure of the average platform (around 7.5 minutes):
Here, local provider SocietyOne Australia explains their platform (around 2.5 minutes):
How do ‘investors’ make money?
Those who lend money through a P2P platform are essentially investing in debt. In the past, the simplest way to buy debt products was through corporate bonds. But until very recently, corporate bonds weren’t available directly to retail investors. That is, ordinary individuals — not investment organisations, or large SMSFs. And that’s not even considering personal lending, which is the most lucrative debt at a rate of around 10% per year. The only way to get exposure to that has been by proxy, via bank shares. This has left a gap in the market. But back on topic.
Investors, or lenders, make their money the same way banks do. That is, they get paid back the principal amount over time, plus interest.
One Reddit user, /u/drivelhead, described their experience with P2P lending in Australia from an investor’s point of view:
‘I put $1,000 into Ratesetter in March to see how it goes – enough to give me a good idea of the returns, but not too much to upset me if I lose it. Initially I just had it in 1 month loans at 3.6%, so my initial returns were small. A couple of months in I moved everything over to 5 year loans, which have been from 9.5% – 10.4%. It’s only been 6 months, but so far I’m averaging around 6% per year after fees and taking all the above into consideration, which isn’t that bad for no effort. It’s certainly better than I’d get at a bank. I’ve not had any defaults yet, but I’m not sure if I’d want to risk much more than $1,000’.
And there’s the hint at the main risk — defaults.
What are the risks?
The main risk to be aware of is defaults. Just like a bank customer can default on a personal loan, a P2P borrow can default on your loan. This is a risk that the investor has to bear. Most platforms do not provide any form of insurance.
P2P lending platforms provide comprehensive product disclosure and risk information. It’s here that you’ll find the stats about average default rates. Many sources put the default rate well below that of the major banks. There is thought to be an emotional factor to this.
The borrower knows that a normal person is relying on them to pay back the money — not a faceless bank. Of course, there are plenty of borrowers out there who’d happily never pay back a close friend, let alone a total stranger. But again, that’s part of the risk.
Other risks include (but are not limited to) late payment; assignment to a debt recovery agent; no early withdrawal (kind of like a term deposit); change in borrower creditworthiness over the loan term; and the fact that your money isn’t guaranteed the way a deposit is.
Who’s doing it in Australia?
At the moment, there are relatively few P2P lending platforms in Australia. Possibly the most prominent, or at least the best publicised, is SocietyOne.
Currently, investment is only open to wholesale clients. The Australian Financial Review reported yesterday that banks have been using SocietyOne to gain a different type of exposure to personal loan debt. But the platform has been lending to Aussie clients for a while now.
MoneyPlace is a platform that is due to launch in Australia within the next couple of months. They’re pitching themselves as part of what’s being labelled ‘the fintech revolution’. Unusually enough, MoneyPlace management has come out as advocating for more regulation of this fledgling industry. Founder Stuart Stoyan recently told spoke at a FINSIA event, saying ‘There’s not enough [regulation]… Our biggest fear is a major failure by a P2P lender, or a company claiming to be one, that causes ASIC or another agency to come in and say: “We’re shutting this down”’.
Marketland is another recently launched platform. As the name suggests, it’s more of a marketplace, where the individual investor is more active in deciding where their funds go. Marketland also offers loss protection and insurance protection. Unlike some other platforms, Marketland offers the ability for investors to buy and sell their debt notes. This, they claim, gives ‘a notable trading advantage’ and improves liquidity.
ThinCats is a P2B platform — peer to business. It’s designed to help SMEs access loans they might not be able to get from banks. It’s somewhat less accessible than P2P platforms; the minimum investment is $1,000. But unlike other platforms, the loans on offer are secured.
[Click to enlarge]
Currently, the only big-name international P2P platform offering lending to retail investors is Ratesetter. Ratesetter was founded in the UK in 2009. It has grown relatively quickly to become Europe’s most used platform. Ratesetter pitches itself as offering the best returns to lenders, with flexible terms from one month to five years. In addition to the set rates, users have the option of holding out for a better rate with different conditions.
Some platforms are still in the ‘seed’ stage. In other words, they’re raising money to cover compliance costs, establish protection funds for investors, and other expenses. For example, late last year UK platform Fruitful was established after raising money through crowdfunding.
On that note, how can you tell whether a platform company — P2P lending, or any other kind of fintech — offers value? One of the keys is getting to know the industry. Understanding the dynamics of the target audience for these loans. Understanding how expectations are managed amongst a large group of investors who may not be experienced in calculating risks. Getting to know all the fees, charges and options the platform may take as the middleman.
If you’re in the middle of researching a fintech small-cap, Money Morning small-caps analyst Sam Volkering’s report is a must-read. It’s titled ‘The At Home Investors Guide to Profiting from Australian Small-Caps’.
In this report, Sam reveals a smart yet simple four step guide to small cap success. Using Sam’s strategy, you’ll be better equipped to find and assess the best small-cap opportunities for your portfolio. Find out how to download your free copy here.
Contributor, Money Morning