What to know about becoming a P2P investor.
Peer-to-peer lending sites are a way of connecting borrowers with investors. Borrowers sign up to look for investors, and investors sign up to become lenders, and enjoy returns that may be higher than what's available with savings accounts, term deposits and other investments. P2P sites are essentially matchmakers, helping borrowers and lenders find each other without getting banks involved.
- Investors can get much higher returns than they could elsewhere and a great deal of flexibility and choice. Some P2P lenders claim that investors are making as much as 12% p.a., compared to around 3% with more safer options. The downside is that investors take on a higher level of risk.
- Borrowers can get lower-interest loans, or avoid some of the more onerous requirements that banks or traditional lenders might place on them.
How does P2P investing work?
As an investor, your money forms part of a loan that's offered to borrowers, and your returns come from loan repayments. Often you'll be one investor among many, with a single loan being made up of money from many different investors, to help diversify your portfolio and reduce the financial risk of borrower default. Conversely, some P2P lending sites may let you invest larger amounts in a single borrower or put up all the money for a loan if you believe you can get a larger return on investment that way.
You sign up with a peer-to-peer investing site, and can start browsing available investments online. These investments take the form of loans, with varying interest rates and repayment terms. Borrowers, drawn by competitive rates, will often have been pre-screened for financial stability and loan repayment ability, depending on the site.
Meanwhile, investors are attracted by the possibility of considerable returns and access to a wide variety of options. Peer-to-peer sites are basically a way to cut the middleman out of loans, so both borrowers and lenders can benefit. You may be able to invest in many different types of loans, and understanding them is an important part of P2P investing.
How to choose a P2P investment site?
There are a variety of different peer-to-peer investment sites to choose from, offering a diverse range of features for investors. You can pick one with benefits that suit your needs.
- Exceptionally high returns on investment relative to other financial products
- Free sign-up and no fees
- The freedom to lend small amounts across a broad portfolio of loans and diversify your risk
- The ability to invest larger amounts in a single company or individual if you believe in their business plan
- Management of administrative and legal documentation on your behalf
- Automatic receipt of detailed credit submissions
- Automated monitoring of loans in your portfolio
- Security in the form of collateral, personal guarantees and similar
- Access to a variety of options to suit your personal appetite for risk and financial plans, including secured and unsecured loans, and different repayment terms
- Access to fund or portfolio managers employed by the P2P lender
- No guarantee of return on investment
- Some or all of your investment may be unrecoverable in the event of borrower default
- Loan terms may vary widely, affecting your returns
- The presence of collateral or guarantees does not necessarily ensure you will get your money back
- Your returns may be dramatically affected by economic downturns
- An increase in interest rates means you might be committed to an under-performing investment
- A decrease in market interest rates means a loan might be repaid ahead of time, reducing anticipated returns
- This type of investment may require closer management than others
The primary risks for investors
- Borrower default or late payment
This is one of the biggest risks posed to investors. If a borrower doesn’t repay their loans, this means the investing lenders’ capital is at risk. If a loan cannot be repaid, the amount you may be able to recover depends on the type of loan.
Some P2P borrowing sites may offer certain protections for investors in the event of this occurring.
- Interest rate risk
As with any fixed term loan or bank term deposit, there's some risk of interest rates rising before the term finishes, which means you can't move your capital into a higher-interest bearing loan until its maturity.
While this is not necessarily a risk to your capital and interest, it’s an issue that you should consider before committing your funds.
Can market lending companies protect you?
Market lending companies also use bank statements and government verification services to make sure they know who the borrower is. The money for the Provision fund comes from charges paid by borrowers. When a borrower applies for a loan, they may be required to pay a Risk Assurance Charge, the amount of which is determined by a number of factors like their credit rating. This means riskier loans may have larger provision funds to protect investors.
How RateSetter protects investors RateSetter has good under-running capabilities. It’s very important that this market lending website knows who it is dealing with in order to apply risk adjusted pricing. This means every person who applies for a loan goes through a background and credit check. RateSetter allocates a risk level to each applicant, and has a provision fund set up as a form of protection for investors. The fund is held by an external trustee and is only used to compensate investors affected by defaulting.
The money for the Provision fund comes from charges paid by borrowers. When a borrower applies for a loan, they may be required to pay a Risk Assurance Charge, the amount of which is determined by a number of factors like their credit rating. This means riskier loans may have larger provision funds to protect investors.
Peer-to-peer investing checklist
Prior to investing, you need to check with the Australian Securities and Investments Commission (ASIC) to see if the P2P platform holds an Australian Financial Services Licence (AFSL).
Know what you are investing in, and read the product disclosure statement (PDS) and Financial Services Guide (FSG) first where relevant. Look for information about:
- Security: Look at the loans security status and determine if they are unsecured or secured.
- Interest rate: Who calculates the interest rate and what factors determine the rate?
- Choice of loans: Are you able to choose who you borrow from or lend to? Can your investment be spread over multiple loans? (This may reduce the risk of losing all your money.)
- Repayments: When will you start to reap the benefits?
- Getting your money back: Do you have the flexibility to change your mind and still retain cooling off rights? If you pull out, can you get your money back? What should I do if the borrower pulls out? What steps will the company take to recover your investment?
- What if the platform fails?: Be prepared in all scenarios. If the company does go under, do you know the steps you'll take to recover your money?
- Fees: You need to know if any fees go to the operator of the platform and if fees exist for investments and repayments.
How do I apply for peer-to-peer investing?
Like all providers who offer consumer loans, P2P platforms must lend responsibly to ensure the investor doesn't lose money. As an investor, you should conduct your due diligence before signing up and compare different options to find the right one for your needs.
The table below shows some of the P2P lending investment options currently available in Australia, and the types of loans they tend to focus on. Depending on your area of expertise, you might choose to invest mostly in business loans, mostly in personal loans, or across both.
If you want to be more discerning, you can even focus specifically on borrowers you believe have a smart business plan and a bright future, and invest similar to how you would with a share trading account.
Peer-to-peer lending sites compared
|RateSetter||Personal and business loans|
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