In our technologically driven age, it’s no surprise peer-to-peer (P2P) lending is gaining serious popularity in Australia and is slowly becoming a preferred alternative to dealing with banks when looking for a loan.
But how exactly do these online lending platforms work, and should you trust them over traditional lenders?
RateCity spoke with Daniel Foggo, CEO Australia of RateSetter, to find out everything you’ve ever wanted to know about peer-to-peer lending.
First off… the basics
What is peer-to-peer lending?
Peer-to-peer lending is when individuals or businesses apply, and sometimes bid, for a business loan or personal loan that is provided by investors and facilitated by a third party. The third party is most commonly an online based platform/marketplace.
How does peer-to-peer lending work?
Individuals or companies looking to borrow will first apply through the P2P platform, in which they will have their credit history, personal identity, employment and income assessed. If the P2P platform believes the individual or company are an ideal borrower and they are approved, they will be matched with one or more investors who will fund their loan. The borrowers’ interest rates are personalised based on their unique credit history.
Investors can choose how much they wish to invest, and sometimes what type of loan their money will be used for. The P2P platform will then match investors with ideal borrowers. Investors review borrowers’ applications and choose one they’d like to financially support.
Loan types, fees and features
There are several things to consider when using a P2P platform to invest or borrow money.
- Secured or unsecured loan
The key difference between these two types is that secured loans involve using an asset as security in the unfortunate case a borrower defaults. This includes vehicles, property or other assets such as jewellery or art. Lenders will traditionally offer a lower interest rate for secured loans as they are less risky.
- Fixed or variable loan
Depending on your preferences, ensure you can choose the right loan type for your repayment needs. Fixed loans allow you to lock in your interest rate for the duration of your loan. This not only allows your repayments to stay the same but helps for budgeting, and protects you from increases in rates. However, it usually means your loan won’t include extra features. Variable loans are a competitive choice if you expect interest rates to drop, and you want to take advantage of features such as extra repayments with no fees.
It’s also important to consider and compare additional loan features and fees.
- Personalised rates – P2P lenders will use your personal information to determine your personalised interest rate.
- Upfront fees – These could include a credit assistance fee or a Risk Assurance Charge.
- Monthly fees – You could be charged a monthly loan management fee.
- Extra repayments – You may be charged for making extra repayments, or repaying your entire loan in full. Some P2P lenders, such as RateSetter, do not charge this fee.
- Maximum loan amount – Unlike with traditional lenders, P2P lenders have a smaller maximum loan amount (usually $35,000 – $45,000).
- Risk assurance charge – this fee will go into a provision fund and is put in place to protect an investor’s interest.
- Lending fees – Some P2P platforms will charge lenders an interest margin fee of 10 per cent on the gross interest received.
- Taxable returns – Any returns earned by investors are also taxable. RateSetter provide annual statements to their investors that ensure tax time is an easy process.
Risks and regulations
What are the risks involved?
As with any loan, there are a series of risks that should be considered by both borrowers and investors.
- Interest rate – borrowers should always ensure that the rate is competitive by using comparison tools to compare it to other loan products in the market.
- Fees – borrowers may have to pay a credit assistance fee, Risk Assurance Charge, and monthly loan management fee with P2P platforms.
- No loan payment protection insurance – if you were unable to pay off your loan (due to injury, illness or redundancy etc.) loan protection gives borrowers the peace of mind of knowing monthly minimum repayments will be met by their insurer.
- Late payments or default – investors may suffer financial loss if a borrower cannot pay back their loan.
- No provision fund protection – P2P lenders can make a claim to the Provisional Fund to compensate investors in the event of borrower late payment or default, however compensation is not guaranteed.
- Can’t reinvest until loan term over – investors are only able to withdraw funds at the end of the loan term.
- Borrower creditworthiness – While P2P lenders perform borrower risk assessments, borrower creditworthiness on an ongoing basis cannot be guaranteed.
- No deposit guarantee – Investments are not protected by depositor protection laws that are in place for Australian ADIs.
What regulations are in place for peer-to-peer lending?
Peer-to-peer platforms are not dissimilar to traditional lenders in that their borrowers’ and investors’ security and satisfaction is their priority. P2P lenders will vet applicants and examine their credit history, employment and income to verify that they are an ideal borrower.
P2P investments are not protected by the Government Backed Guarantee on Deposits.
What is the Government Backed Guarantee on Deposits?
In the event of your bank going under, the Australian Government guarantees deposits up to a cap of $250,000 per account-holder, per Authorised Deposit-taking Institutions (ADI).
However, they are regulated by the Australian Securities and Investments Commission (ASIC). According to the RateSetter, they worked with ASIC to become the first licensed company to provide P2P lending to retail investors and SMSFs.
“This involved working with ASIC to navigate a range of legal and regulatory issues and to play a meaningful role in establishing what we believe is a robust regulatory framework for peer-to-peer lending, where investors participate via a registered managed investment scheme.”
Pros & cons for borrowers:
- Easy online application process
- Good credit = lower interest rate
- Smaller maximum loan amount than banks
Pros and cons for investors:
- Choose borrowers personally
- Avoid big lending institutions
- No Government Backed Guarantee on Deposits
Why are people turning to peer-to-peer lending?