How does peer-to-peer lending compare with savings accounts?
Peer-to-peer lending offers the potential for higher interest rates. We assess the opportunities and risks involved.
Savings accounts can deliver solid returns for an fixed term, many with "bonus" interest for an introductory period. Typically, you'll find up to 3.5% for the bonus interest rate and between 1.5% p.a. and 2.5% p.a. for the standard ongoing rate.
Compared to that, a potential rate of return of 12% p.a. -- the amount claimed by some peer-to-peer lenders -- seems very appealing. So what's involved?
How does peer-to-peer lending work?
Peer-to-peer lenders allow you to invest money which can then be loaned to others. When your money is repaid, you'll also receive interest payments. There are already three peer-to-peer lending organisations active in Australia, and New Zealand-based Harmoney has recently entered the market after receiving $200 million in investor funding to expand.
Harmoney's model provides an illustrative example of how the process works. The minimum investment is $500. You can choose the kinds of loans you're willing to fund based on purpose, total or the credit grade for the borrower. Once a borrower signs up, repayments will be made regularly into your account.
The return varies depending on how you spread your risk and structure your investment, but Harmoney reports that many of its investors enjoy a 12% p.a. return on their investments. Even at half that level, the return is stronger than most savings accounts.
As with any investment, higher returns come with additional risks. Unlike a saving account, your interest isn't guaranteed. You're dealing with borrowers who might be late with payments, or who might even lose their jobs and default.
If you're interested in peer-to-peer lending, there are strategies you can take to reduce that risk. Many peer-to-peer institutions encourage customers to develop a portfolio of loans to multiple borrowers, so that the risk isn't restricted to a single loan. While those organisations will also work to recover funds if a borrower does default, you still need to assess the risk carefully.