Be aware of the return and risks of peer-to-peer investing.
Peer-to-peer lending is a process of borrowing money through non-traditional lenders. Individuals and companies can use P2P if they need a loan. Managed investments are the typical financial product people are looking to receive when they choose P2P.
Investors are attracted to this type of lending since the interest rate offered for their investment is higher than a typical financial institution – up to 9.70% p.a. The lower interest rates, offered through P2P, are more appealing than traditional lenders so many borrowers may choose to get a loan this way.
An investor has a lot of control over the investments. The investor can decide how much to invest, and depending and how their money will be invested (which is subjective to the lending platform). Read about the difference between savings accounts and peer to peer investing here.
What are the risks of peer-to-peer investing?
- Borrower late payment or default
This is one of the biggest risks posed to investors. If a borrower doesn’t repay their loans, this means that lenders’ capital is at risk. Peer-to-peer lending involves matching investors who want a better return on their money with borrowers who require a loan at a fair interest rate.
A borrower or series of borrowers to whom your funds are lent may delay or stop payments on a loan or default on a loan. You may suffer financial loss if you don’t have any warranty or protection for your investments.
- Interest rate risk
As with any fixed term loan or even bank term deposit, there's some risk of rising interest rates before the term finishes, which means you couldn't move your capital into a higher-interest bearing loan until its maturity.
Whilst 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 service to make sure they know who the borrower is.
Case study: How RateSetter protects investors
RateSetter has good under-running capabilities. It’s very important that the market lending website knows who it is dealing with. RateSetter uses risk adjusted pricing. What does this mean? Every person who applies for a loan goes through a background and credit check. RateSetter allocates a risk level to the person applying. RateSetter’s Provision fund is set up as a form of protection for investors. The fund is held by an external trustee and will only be used to compensate an investor who has be affected by defaulting. RateSetter can’t use the money in the Provision Fund for its own purposes.
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.
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. Don't blindly give away your money without reading the product disclosure statement (PDS) first. In the PDS, look for information about these features:
- 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?
Many of the loans organised by P2P lending platforms are used to consolidate debts or to buy consumer goods such as cars. Borrowers pay back the amount of the loan to the investor with interest. The interest rates may be higher than the rates offered by traditional banks because investors can get rates based on the borrower's personal circumstances.
Applying to be an investor
Like all providers who offer consumer loans, P2P platforms must lend responsibly to ensure the investor doesn't lose money. You can become an investor when you go a reputable P2P website and follow the prompts.