Peer-to-peer lending has the potential to bring about massive changes in the Australian financial services industry. These companies, which also go by the name of P2P lenders or marketplace lenders, have been operational in the country for the last four years but have only now started making a substantial impact.
They have rapidly increased their business volumes by routing personal loans to individual borrowers at rates that are generally less than what banks offer. These loans are financed by investors who earn a rate of interest that is more than double what they would get on a bank deposit for a similar period of time.
P2P lenders are able to achieve this feat by shunning the bricks and mortar model of traditional banks. They have very few employees and extremely low overheads. Their business operates on the basis of their websites, which allow investors to place money with them and potential borrowers to access these funds.
In addition to making funds available at low rates to borrowers looking for personal loans, P2P lenders provide an opportunity to retail investors to earn high returns on their savings.
What are the investment options for retail investors?
Most “mum and dad” investors would not like to risk all their money in the stock market. They would prefer to put part of their savings into something secure like a bank deposit. Unfortunately, this form of investment pays abysmally low rates of interest.
The four major banks, ANZ, Commonwealth Bank of Australia, National Australia Bank, and Westpac Banking Corporation offer deposit rates that are in the region of 3% per year.
Marketplace lenders offer an excellent option to retail investors who are looking for a higher rate of return. But the question that any investor would ask before lending money using the services of a P2P web portal is, “Are my funds safe?”
In order to answer this question, it is important to first understand how a P2P lender functions.
Making a loan through a P2P lender
The basic investment principle that says risk increases in direct proportion to the return available, holds true in the case of amounts lent through marketplace lenders. The higher returns that can be obtained through P2P lenders carry a greater degree of risk than a bank deposit and it is a real possibility that an investor could lose a part or even the entire amount invested.
The Australian Securities & Investment Commission has clarified that the government guarantee on term deposits does not apply to funds invested through marketplace lenders.
Despite the non-availability of government protection, funds placed through P2P lenders are quite safe. There are two prominent companies in the country that investors can consider investing through. The first, SocietyOne, a home-grown marketplace lender, has been in existence since 2012. The second firm, RateSetter, was launched in the UK in 2010 and has been in Australia since November 2014.
RateSetter accepts money from retail investors. Currently, SocietyOne allows only “wholesale investors” to use its platform and a minimum investment of $25,000 is required. But the company is in the process of allowing “mum and dad” investors to use its platform.
Investors who have placed their money using these platforms have obtained returns in the region of 8 to 10% or even more. Their money has been totally secure as P2P lenders have well-developed credit appraisal systems in place. Potential borrowers are subjected to a process that determines their repayment ability before they are allowed to take a loan using the P2P lender’s website.
Another practice that is followed by marketplace lenders is that they allow investors to spread out their investment among multiple borrowers. If a borrower is taking a loan of $10,000 it may be provided by 10, 20 or even more lenders. This helps in minimising risks and allows investors to earn a high return secure in the knowledge that even if a borrower defaults they stand to lose only a small amount.
Investors should take out a little time to understand how these two major companies operate and the practices that they follow to ensure that the money placed by them is safe.
Although the P2P lending industry had a slow start four years ago, the situation has now changed. A number of new entrants have come into the market and many more are waiting in the wings.
But SocietyOne is the pioneer in this field and the only company that has a record built up over the years. Currently, investors lending money through this firm’s portal can earn gross interest rates ranging from 7.6% for borrowers categorised as AA, to 13.55% for D grade borrowers (rates updated 15 August 2016).
The actual returns that investors would receive would be slightly less as they would be reduced by SocietyOne’s service fees, currently 1.25% of the principal amount, and any loan impairments for the selected credit grade. It is quite safe to assume that the return will be several times that of a bank deposit.
‘Mum and dad” investors are allowed to invest through this P2P lender. Currently, an investment for a one-month period earns an annualised return of 2.9%, after fees. The returns for one year, three years and five years are 4.8%, 8.8% and 9.9% respectively (rates updated 15 August 2016).
RateSetter maintains a provision fund that is used to protect investors from delayed payments and defaults from borrowers. The company publicises its figures and currently it has over $24 million in loans outstanding against which it has built up $1.3 million in its provision fund (As of early 2016). The provision amount is twice the sum required to make up for expected defaults.
Investors can start with lending sums as low as $10 for a period of one month. Of course, this is only RateSetter’s way of indicating that it is open to accepting small investments. Many investors start with small sums and once they gain confidence, they gradually build up their portfolio of loans.
An opportunity to earn higher returns
P2P lenders give retail investors the means to earn the margins that banks have traditionally kept to pay for their high costs and overheads. Using technology and well-developed processes, P2P lenders have taken the place of banks and passed on the resultant savings to borrowers and investors.
Additionally, they ensure that money is loaned only to borrowers who meet certain basic eligibility criteria.
Many “mum and dad” investors have already taken advantage of the investment opportunity that P2P lenders have presented and earned returns that are much greater than what they would have obtained from a bank deposit.
While it is not advisable to place a significant proportion savings with P2P lenders, it is definitely worth considering this option to be a part of a retail investment portfolio. Also see our disclaimer.