In part one of our Ratesetter review, I talked about the frustration I have had personally when investing in Australia and looked to Ratesetter as an alternative.
Then I showed how easy it is to sign up to and start investing.
However, many questions remained. Therefore, part two of our review aims to give you a detailed overview of how it works by answering the following most asked questions:
- What is Ratesetter?
- How Does Ratesetter Work?
- How Safe Is Ratesetter?
- How Does Ratesetter Make Money?
- How To Use Ratesetter?
If you don’t want to read all the way to the end of the article, although we do advise it, we concluded that essentially Ratesetter’s track record makes it a compelling investment option backed up by their “Provision Fund”.
Of course, the key word here is “invest”. Ratesetter is an investment and as such despite its promising past performance you should only really be investing money that could potentially be lost.
In the the interest of full disclosure: I am personally making Ratesetter a part of my investment mix (I am not a financial advisor but I do like to try and make good investments).
What is Ratesetter?
Ratesetter is one of the leading peer to peer lending companies. It was originally founded in 2010 in the UK and it promises to give investors the opportunity to earn returns on their investment that are higher than a savings account.
The Australian version of the website was launched in November 2014 and it is this version of the service that we will be focusing on in this article.
How Does Ratesetter Work?
Ratesetter works in much the same way as other peer-to-peer lending companies. In case you are unsure of what this means here is a quick overview.
It is really quite simple.
When you want to invest money with Ratesetter you choose the amount you want to invest as well as the amount of time you want to invest for.
Once you have done this, Ratesetter matches you up with a borrower who needs some money and is happy with the rate. Once the borrower has your money, they spend it as they wish, paying the fees back as they go along.
Now, while this all sounds good, I’m sure a lot of our readers are wondering “What if the lender doesn’t pay my money back?”
Well, this is the really clever thing about Ratesetter. Ratesetter was one of the first peer-to-peer lending companies to use the idea of a provision fund. Ratesetter’s provision fund is made up of charges paid by the people who borrow money from the service.
The real genius behind the provision fund in my opinion is not that it exists (although this is awesome) but that the amount paid by the borrower to the fund changes based on their risk profile. In other words, the more likely they are of default – the more money charged and the bigger the provision fund gets.
All this money goes into a big pot and it is used to cover lenders if the borrower is either late with their payment or fails to make one at all.
Now, it is worth mentioning that this provision fund is nowhere near big enough to cover all the money that Ratesetter has lent out. In fact, according to their website they currently have over $70 million of loans outstanding and about $4 million in the provision fund.
It is absolutely true that if all the $70 million dollars Ratesetter currently has loaned out were defaulted on, there would be a lot of people losing a lot of money. However, the people behind Ratesetter do not believe that this is likely.
“Through the GFC, defaults on personal loans didn’t even double…” Mr Daniel Foggo, CEO of Ratesetter Australia said in the Sydney Morning Herald.
What they do believe is that out of that $70 million, only a small amount of it will turn out to be “Bad Debt”. The job of the provision fund, therefore, is not to cover the entire debt that Ratesetter have loaned out, but instead cover the amount that they have worked out to be bad debt.
According to their website, they have estimated that around $2.3 million dollars of their money is bad debt, meaning that the $4 million available in the provisions fund more than covers this.
Now, it is worth mentioning that this Bad Debt estimate is just that, an estimate. The amount of actual bad debt could, in fact, be higher or lower. While they do have a 173% coverage (April 2017) of the estimated amount of bad debt, it is worth remembering that there is no guarantee the bad debt estimate will be correct.
This brings us nicely onto our next question.
How Safe is Ratesetter?
Even with borrowers under considerable stress it appears that Ratesetter is safe. This is mainly due to two reasons. Firstly, because they check everyone that tries to borrow money using the service and secondly, because of the use of their provision fund.
When people apply to borrow money using Ratesetter, they perform all the necessary checks to ensure that the person is not a credit risk. On their website, they claim that everyone who borrows using the service is:
B. Has a regular source of income (or assets)
C. Has an acceptable credit history
Just like a bank, Ratesetter wants to decrease the chance of their loans not being repaid and as such, they will, in theory, only choose people they believe will be able to pay off the loan.
Therefore, because of the fact that they check who they lend money too and also because of their provision fund, they actually claim that at the moment not a single investor has lost any money using their service!
This is no small claim as they have been around for seven years and as seen in the figures above, they have dealt with a significant amount of money.
They are also regulated in the UK by the Financial Conduct Authority, and most importantly in Australia by the ASIC which should keep them in check.
However, as (to their credit) they are keen to point out on their website “Past performance is no guarantee of future success”.
Essentially, this is not a bank account. Like with other investments such as the stock market there is a chance that you will lose money. Ratesetter isn’t regulated by the Financial Services Compensation Scheme which means that should the worst happen, investors aren’t covered by the government.
So, what does this all actually mean? How safe is Ratesetter actually and is there a chance all that debt could be defaulted on? Well, to be honest, if I had a good answer to that I’m sure I would have made my millions by now!
Like many other financial services, the health of Ratesetter depends on a number of things including the economy around it.
The fact that not a single person has lost any money in the seven years that Ratesetter has been in operation is incredibly comforting for would-be investors. They have a large amount of money in their provision fund, more than their estimated amount of bad debt, and this has so far proven to be more than enough to offset any individual problems lenders have had.
The biggest risk would be if there was a global financial crisis again and it is only then that we will really know just how robust Ratesetter is.
Basically, as with any investment, while Ratesetter certainly seems pretty safe, only invest what you can afford to lose.
How Does Ratesetter Make Money?
Ratesetter makes its money by taking a portion of the interest paid on your investment. Currently, this stands at 10% of the gross interest received.
While this seems like a lot, the good thing is that all the interest rates shown on the Ratesetter website are the rate you will receive post fee. This means that should you sign up to their one year fund that offers 4.9%, you will receive 4.9% from Ratesetter.
As well as this, Ratesetter makes money by charging a fee to borrowers.
However, even for borrowers it isn’t that bad as the fee is simply added onto their loan and they pay it back as they pay back the rest of the loan.
Now, while all this evidence of low fees is certainly good news for investors, at the moment it does mean that the real answer to the question “How does Ratesetter make money?” is quite simply, it doesn’t!
Well, at least, not at the moment. While in 2015 Ratesetter did make a small profit of GBP 476,000, in 2016 it was back in the red with a pre-tax loss of GBP 4.9 million. Not a small amount.
Now, of course, Ratesetter say that this was part of their overall strategy. The lack of upfront fees hasn’t always been the case and in 2015 they actually charged a fee to users. This change is what they blame their losses on they now lack an upfront fee.
They do, however, claim that this will make the company more sustainable in the long run which is great news for investors if true.
How to Use Ratesetter?
Ratesetter is really easy to use. In fact, they have tried their best to make it as close to a regular savings account as possible. This means that there is a low barrier to entry for potential customers.
Much like when choosing an ISA or other type of saving account, when you invest your money you have to choose a product. Ratesetter currently offers four products.
- 1 Month market
- 1 Year market
- 3 Year market
- 5 Year market
Much like traditional savings accounts the longer you commit to leaving your money in their hands, the higher the interest rate you can receive.
In fact, Ratesetter’s five year market currently (Mar 2017) offers an excellent return on investment of 9.2%. In comparison, the one year market offers a still decent 4.9%, while the one month offers 3.4%. While this is much less that the five year account it is much more than most savings accounts can offer at the moment.
One of the great things about these accounts are the options that are available. For example, you can choose to invest as much or as little as you want (well, as long as it is over ten dollars). This means that there literally is a product for everyone.
Once you have deposited your funds, you are then free to either set your own rate or invest at the market rate. This means that it is actually possible to get more than the advertised rates as you can choose to offer your loan at more than this.
Of course, the problem is that if there is another similar loan available on the market at the market rate, it is highly unlikely that anyone will choose your loan. If your loan fails to get picked up, instead of it earning interest it will just be sat in your account.
Because of this, Ratesetter claims that most investors simply choose the market rate for their investments. Still, it is nice to have options as it does make you feel like you are in control of your money.
Once your money is invested, it will be matched to loans. Now, one thing worth mentioning is that the term time of these loans will be longer than the term time of your investment. For example, Ratesetter claim that a one month investment will be put into a 6-24 month loan.
What this means is that while you should receive your fees after your term time, if there are no funds available you may have to wait until there are sufficient lender funds to repay your loan.
Hopefully, this article has answered a few of the questions you may have had about investing with Ratesetter. As you can see from the answers to the questions in the article, Ratesetter seems to be a fairly safe way of getting some decent returns on your investment.
The fact that there are so many options and you can invest as little or as much as you want certainly works in Ratesetter’s favour, as does the fact that so far they claim that not a single investor has lost any money when using their service.
Of course, this isn’t guaranteed so when investing your money, please make sure that you do so only with money you can afford to lose.