Peer to Peer lending
Peer to peer lending matches people who have money to invest with people who are looking for a loan. A more appropriate term for this practice is marketplace lending because an online platform, usually a website, is used to match investors with borrowers.
Even though the term marketplace lending best describes this type of lending, on this page we refer to it as peer to peer lending (or P2P lending) as these are the terms most people use.
For both investors and borrowers, there are a number of things to consider before using this type of lending.
Peer to peer lending involves borrowing money without going through a traditional lender such as a bank, building society or credit union. It can be used by individuals or companies that need a personal or business loan.
The money comes from investors who can be individuals or companies.
People who invest through this type of lending are buying a financial product, typically a managed investment product; while borrowers are taking out a loan that is repaid over time, with interest.
P2P lending sites and companies
P2P lending involves a financial service provider (the lending platform) that acts as an intermediary between investors and borrowers.
The platform will promote itself to both borrowers and investors, and makes money by charging fees to both parties.
Investors may be attracted to this type of lending because of the interest rate they are offered for their investment. Borrowers may choose to get a loan this way because it may offer loans with lower interest rates than they can get from a traditional lender.
Interest rates and the methodology for calculating interest may vary among the lending platforms.
Matching investors with borrowers
An investor decides how much they want to invest and, depending on the lending platform, how their money will be used. For example, an investor may be able to choose to fund one loan in particular or be able to invest in a portfolio of loans. In addition to this, investors may be able to choose the minimum interest rate and select a loan period that fits their needs.
However, in some cases, the investment decisions will be made by the platform operator or the investment manager.
Repayments from borrowers are collected through the lending platform and passed on to the relevant investors at predetermined intervals. The investor’s capital can be returned as part of the repayments or at the end of the loan period.
When borrowers apply for a loan, the platform operator will evaluate their suitability by checking their credit history and their capacity to repay the loan. These factors allow the platform operator to assess the lending risk. Not all platforms disclose the lending risk of each borrower.
The platform operator keeps the personal details of all investors and borrowers confidential.
Peer to peer lending for investors
Generally, P2P lending platforms are set up as managed investment schemes. This means the platform operator must have an Australian Financial Services Licence (AFSL) that allows them to run the scheme and must comply with the Corporations Act when they provide the product.
Things to check
Before you invest, you should check ASIC Connect’s Professional Registers to see if the lending platform holds an AFSL. You can also check ASIC Connect within the ‘organisation and business names search’ to see if a scheme is registered with ASIC. Registered schemes will have an Australian Registered Scheme Number (ARSN) that can also be searched.
The platform’s website should have the details of the scheme registration and AFSL. If the platform lends to consumers it should also have details of its Australian Credit Licence.
Understand the investment
Before you hand over your money always read the product disclosure statement (PDS). In the PDS, look for information about these features:
- Security – Are the loans secured or unsecured?
- Interest rate – How is the interest rate determined and by whom?
- Choice of loans – Can you select the loans and/or borrowers? Can your investment be spread over more than one loan? (This may reduce the risk of losing all your money.)
- Repayments – How long will it take before you get any money back?
- Getting your money back – Do you have any cooling off rights if you change your mind? Do you have the ability to redeem your investment and get your money back?
- What happens if the borrower defaults – What will the platform do to recover your investment? Who pays the expenses associated with any recovery action?
- What if the platform fails – What will happen if the platform operator becomes insolvent or goes into external administration?
- Fees – Are there any fees payable to the platform operator? Is there a fee when you invest as well as a fee for handling repayments or accessing your money early?
If you don’t understand or feel comfortable with these features, consider investing in other financial products.
You should also consider whether investing in a P2P lending loan suits your investment goals. See invest smarter for our tips on matching an investment with your needs and objectives.
Important: Have you read the PDS?
Before you commit your money to a P2P lending loan make sure you read the PDS and understand the significant features, benefits, costs and risks of the investment.
This section explains some of the common risks of P2P lending. Each lending platform is unique, so you should read the relevant section of the PDS for the specific risks of the platform that you are considering investing through.
In most cases, the company operating the lending platform does not lend its own money, so all the lending risk is taken by investors. This means you are likely to lose some or all of your money if the borrower does not repay their loan.
This risk is reflected in the comparatively high returns you are likely to receive for your investment. However, it pays to remember that you may still lose your money even if you choose a loan that has been listed as low risk.
See risk and return for more information about assessing your appetite for investment risk.
Assessing credit risk
The operators of P2P lending platforms often make claims about a borrower’s ability to repay the loan. The operators may also rate or grade borrowers by their level of creditworthiness.
It’s important to keep in mind that these ratings are based on a point in time assessment only and are not the same as the ratings used by an external credit rating agency or even consistent with the ratings used by other P2P lending platforms.
Before you invest you should understand and feel comfortable with how borrowers are assessed before they are given a loan. The PDS should explain how this is done.
Credit assessment is a highly skilled and complex process. You are relying on the platform operator to assess and rate a borrower, not an external credit rating agency. A high number of defaults or late repayments by borrowers could be an indicator of the platform operator’s poor credit assessment process. Ask the operator for information about its track record of assessing borrowers.
What if the borrower can’t repay the loan?
It’s important to remember that a borrower’s ability to meet repayments can change over time (for example, because of illness, unemployment or a change in their financial circumstances). If a borrower can’t keep up the repayments, they have the right to apply for a ‘hardship variation’. This can involve a change to the terms of their loan such as changing the amount or timing of their repayments.
If you have invested in a loan that is the subject of a hardship variation this may mean the term of your investment is extended and your returns may be less than originally expected.
Borrowers also have the right to complain to an external dispute resolution (EDR) scheme if they are not happy with how the platform operator has responded to their request for a hardship variation.
The cost of assessing a complaint is charged to the platform operator regardless of the outcome. This means the operator will have to pay the scheme’s fees (which can range from a few hundred to several thousand dollars), as well as any compensation awarded by the EDR scheme to the borrower. As an investor, you should check to see how the lending platform will recover these costs.
Investments in P2P lending are not deposits
Investing through a P2P lending platform is not the same as putting your money in a deposit account with a bank, building society or credit union. The Government guarantee on deposits that applies to savings products such as a term deposit does not apply to funds invested in peer to peer lending.
In addition to this, if your investment is lost due to fraud or an error within the lending platform, there may not be a procedure in place to compensate you.
Some platforms do maintain a fund that may compensate investors that suffer losses due to borrower defaults. However, if there are a large number of defaults, the fund is unlikely to have enough money to compensate all investors.
Make sure you understand how you will be compensated if the loan is not repaid and how claims against defaults are made and assessed.
How to complain
As an AFSL holder, the operator of the lending platform must have a complaints handling procedure and must respond to any complaints. You can find out how to complain by reading the PDS or by contacting the platform operator.
If you are not satisfied with their response you can take the matter to an external dispute resolution (EDR) scheme. Details about which scheme the platform operator belongs to should be in the PDS.
Peer to peer lending for borrowers
Most loans organised by P2P lending platforms are used by borrowers to consolidate debts, to fund large purchases such as cars, or for business purposes. However, it is possible to get larger loans to buy property or refinance a mortgage.
Like a loan from a more traditional lender, borrowers pay back the amount of the loan, plus interest. However, interest rates may be lower than the rates offered by traditional lenders. This is because borrowers can get interest rates based on their personal circumstances, such as their credit rating.
Some lending platforms keep a fund of money that it can use to compensate investors who suffer losses due to borrower defaults. Borrowers may be asked to pay a fee that will be paid into that fund. The fee will depend on the creditworthiness of the borrower.
Applying for a loan
Like all credit providers who offer consumer loans, P2P lending platforms must lend responsibly.
If you are applying for a loan through a lending platform, you should expect to be asked the same questions that a traditional lender will ask to assess your suitability for the loan and your ability to repay it.
The lending platform will also check your credit report. See credit reports for more information about what’s included in your credit report.
The credit provider for your loan will be either the platform operator or a custodian company that enters all loans on behalf of the platform and the investors.
If you have difficulties repaying your loan, you will be dealing with the platform operator or the custodian company, rather than the investors.
For individual borrowers (not businesses) the loan will be a consumer credit contract, so the platform operator will need to have an Australian Credit Licence and comply with the National Credit Act when it sets up the loan.
Before you sign up for a loan
Before you sign up for a personal loan through a P2P lending platform you should always read the information on their website and any loan documents to make sure you understand the terms and conditions of the loan.
To help you assess the loan, take a look at the comparison rate to see how much the loan is likely to cost you with the fees included. You should also check whether you will need to pay any upfront fees to set up the loan.
It’s also important to shop around and compare the marketplace loan with the loans being offered by traditional lenders.
If things go wrong
When you sign up for a loan, you will be given a credit guide that explains who the credit provider is, and what the platform operator does. This guide will tell you who you should contact if you have any complaints, or if you have problems repaying the loan.
The credit guide will also include details of the external dispute resolution (EDR) scheme you can contact if a dispute with the P2P lender cannot be resolved. For more information about lodging a complaint, see how to complain.
P2P lending might seem like a good way to get better returns as an investor or a lower interest rate as a borrower, however, there are a number of things to check before you hand over your money or sign up for a loan.
This article has been reprinted from https://www.moneysmart.gov.au/investing/managed-funds/peer-to-peer-lending and has been provided to help investors and entrepreneurs source correct information on p2p lending.