What is peer-to-peer lending?
And is it all it's cracked up to be?
Peer-to-peer lending, sometimes called P2P for short, is where borrowers and lenders are connected through an online middleman. The theory is that using an online platform means the middleman could avoid the cost structures of traditional banks and offer better rates – to both borrowers and investors. In other words, P2P lending is when you either borrow or lend money to a stranger.
While it sounds simple, when you look a little closer there’s a lot more to P2P lending than first meets the eye.
Background of P2P
Peer-to-peer lending was legalised in New Zealand in 2014 following trends overseas.
The P2P lending provider acts as a matchmaker, arranging the exchange through its website. It does the credit-checking, deals with the repayments and interest payments, and chases up unpaid loans (defaults). It makes its money usually by charging fees to both the investor and borrower – and it may also take a cut of the repayments.
P2P lending is often pitched as a way for everyday people to borrow relatively small amounts from other everyday people for things like buying a car, home renovations, and holidays (though whether you should take on debt for these things is another matter!). The borrower is then charged varying interest rates depending on their profile.
P2P lending – a closer look
Reportedly New Zealand’s largest P2P lender only funds 25 percent of loans with ‘mum and dad’ investors, and meets most funding needs with institutional investors, including one of New Zealand’s largest banks, who are also a shareholder of the P2P business who facilitates the lending. Other shareholders and lenders include New York and UK based investment firms – which means this is hardly the lending between “everyday people” which is what we might otherwise believe.
Interest rates for P2P borrowers are usually between seven to 40 percent. This means that P2P lending may not be the “lower cost” alternative of obtaining finance that it’s made out to be.
Despite the short history of P2P lending in this country, the biggest P2P lender in New Zealand has clashed with the Commerce Commission. On one occasion this involved the lender being fined for being misleading, while in another instance a High Court judge found that the way the P2P lender was structured went “beyond mere matchmaking” and declared its credit fees to be unreasonable.
Risks (and possible rewards) of P2P
Aside from the general risks of any investment, peer-to-peer lending has some unique risks (and possible rewards). This includes:
- For investors, the reward is quite simple: a higher interest rate than you’ll get from a bank. The riskier the loan the investor chooses to invest into, the higher potential returns. Of course, the higher the risk, the higher the chances are of the investor not receiving some or all their funds back. This is a very real risk, as the loans are usually unsecured.
- Some providers offer ways to reduce this risk - such as spreading your loans across more borrowers or guaranteeing the repayments themselves. This still doesn't eliminate the risk.
- You probably can’t withdraw your funds whenever you want.
- P2P lending providers aren’t well-regulated like banks.
- P2P lending hasn’t been around long, and since it was first legalised in New Zealand the overall economy has been going quite well. This may mean that investors or lenders are lulled into a false sense of security with this sort of lending. Many Kiwis who remember the failure of most New Zealand finance companies last decade know how difficult it is for high-risk lenders to stay afloat during an economic downturn. In other words, times have been good for investors over recent years, but how will P2P lenders go during tougher economic times?
Should you invest by P2P lending?
P2P lending is a high-risk, high-return investment. This means most people shouldn’t invest unless they can afford to lose the money they’re putting into it.
Before turning to P2P lending, it will pay to consider: