It’s no surprise that online lending – or peer-to-peer (P2P) lending – is gaining serious popularity in Australia.
As trust in big banks falls on the back of scandals being surfaced by the Royal Commission into Banking, peer-to-peer lending 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?
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 and fees
Depending on your preferences, ensure you can choose the right loan type for your repayment needs.
There are several loan types to consider when using a P2P platform to invest or borrow money:
P2P lenders will use borrowers’ personal information to determine their personalised interest rates.
Involves 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.
Borrowers take out a loan without an asset as security. As this poses a higher risk to the lender, borrowers are usually charged a higher interest rate than secured loans.
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 fees involved with any P2P loan.
- 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 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. Some platforms provide annual statements to their investors that ensure tax time is an easy process.
What are the risks involved with peer-to-peer lending?
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. With traditional lending, this would mean that 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 Institution (ADI).
Unfortunately for Australians using P2P platforms, this guarantee is not provided. However, P2P platforms are regulated by the Australian Securities and Investments Commission (ASIC).
Pros & cons of peer-to-peer lending for borrowers
- Easy online application process
- Good credit = lower interest rate
- Smaller maximum loan amount than traditional banks
Pros & Cons of peer-to-peer lending for investors
- Choose borrowers personally
- Avoid big lending institutions
- No Government Backed Guarantee on Deposits
How can I increase my chance of getting approved for a loan?
As with any financial product, there are a range of things borrowers can do to increase their chance of approval.
- Check your credit file and raise any issues before the lender asks, explaining what happened and why it won’t occur again. It’s not uncommon for credit reports to have incorrect information, or the debt of someone with a similar name to yourself incorrectly added to your file.
- Pay off your debts. Lenders will assess your bank records and repayment history when you apply for a loan. If you have any existing debt(s), lenders will be quick to judge your riskiness as a borrower, and could give you a higher interest rate or not approve you at all. If you have multiple sources of debt you should focus on one debt at a time and budget to pay it off.
- Reduce your credit card limit. If you have a credit card limit of $5,000 for example, lenders can assume your credit card is carrying $5,000 in debt, even if you only owe $500.
- Save consistently for at least a few months before submitting your personal loan application. This will show lenders that you have stability in your budget and have good financial self-control.
- Set up a budget and stick to it. If you can show you are responsible with your money, that will count for a lot.
Tip: understand your chance of approval before applying
RateCity’s chance of approval system for personal loans can tell you the likelihood you’ll get approved before you apply for a loan.
Can I get a no credit check loan online?
Credit checks are compulsory in Australia when applying for any financial product from a lower-risk provider (such as a bank, credit union or mutual bank). However, there are no credit check providers out there – also known as payday lenders.
Payday loans come with their own risks, so ensure you’ve done your research before applying for any financial product.
Want to know more about peer-to-peer lending?
RateCity spoke with Daniel Foggo, CEO Australia of RateSetter, to find out everything you’ve ever wanted to know about peer-to-peer lending: