What is Peer to Peer lending?

Posted on: 28 April 2015 by 50connect editorial

Ben Butterworth explains how the failure of banks to provide affordable borrowing has created a financial technlogy boom for investors around Peer to Peer lending.

What is Peer to Peer lending?

Peer to Peer (P2P) Lending has been making waves in the troubled waters of the traditional finance industry of late. It hands control back to the investor and gives those looking for either income or growth a real alternative to savings with banks. But how does it work and what are the things to look out for before you dive in?

P2P Lending works by circumventing the traditional banking model, matching businesses and individuals that want to borrow money directly with those that can afford to lend it. By receiving interest directly from the borrower, lenders (investors) earn the interest margin usually retained by the banks providing higher rates of return on their money. In turn borrowers gain access to alternative sources of funding, it’s a win-win for both parties.

The industry is growing fast, by the end of 2014 over £2bn had been lent through P2P in the UK since inception, most incredibly over £1.7bn of that was lent in 2014 alone. The government has also thrown its weight behind P2P Lending by announcing special measures in support of the industry including reviewing a new P2P ISA and even lending money to British business through the British Business Bank.

This new industry is part of the Financial Technology (Fintech) movement, specifically responding to the demand for credit that banks and other traditional financial institutions no longer service. P2P has met this demand through the application of new technology and the increasing availability of information.

P2P Lending is often categorised with Crowdfunding but the two are very different. As a P2P Lender, you are investing in debt, lending your money at a fixed rate for a fixed period of time. As a Crowdfunding investor your money is in equity (shares) with no idea of the term or return on investment.

As a P2P Lender you can expect to receive anywhere between 4-10 percent plus depending on the borrower, the loan being made and the security. There are a number of different P2P Platform models that lend to borrowers in different ways and offer varying levels of capital protection.

Types of P2P Platform
 

1.       Consumer – loans to individuals for home improvements, car, debt consolidation etc.

2.       SME – Small and Medium size Enterprises, loans to grow business

3.       Property – loans to property developers and investors

As of April 2014 the P2P lending industry has been regulated by the Financial Conduct Authority (FCA). However, it is not covered by the Financial Services Compensation Scheme (FSCS), the government guarantee of up to £85,000 on your savings within a bank, so your capital is at risk if the borrower defaults on their loan.

Ways to mitigate the risk:
 

1.       Diversification  P2P lending brings together a number of lenders who lend to a single borrower meaning that you can lend smaller amounts into a larger number of loans thereby diversifying your risk.

2.       Provision Funds  Those P2P lending platforms offering unsecured loans will usually operate a provision fund to compensate those who have lent into loans that default, this is commonly about two percent of total funds lent out via the platform.  

3.       Traditional Security  As well as unsecured lending to individuals and businesses, some P2P lending platforms offer loans secured against an asset, for example property. Loans are supported by a first legal charge over the property which is registered with the Land Registry. In the case of a borrower default, the asset can be repossessed and sold in order to repay the lenders their capital.

As with all investments, it is never wise to put all your eggs in one basket, so putting your entire life savings into one unsecured P2P loan may not be the most sensible approach. But as a way to invest or to get access to income while protecting capital, P2P lending supported by a real security is worth a look.

 

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About the author 

Ben Butterworth is Head of Lender Relations at Proplend

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