Peer-to-peer lending explained

For newbies to peer-to-peer loans, you might find yourself asking a lot of questions or harbouring some scepticism on this relatively new credit option.

Such as, is this a trusted platform and how exactly does it work? Well, don’t get flustered, relax and read on, we have all the information you need to know right here.

Most of us aren’t stranger to the term “P2P”, and in today’s age, it serves us to be au fait with all the latest and greatest innovations. This is why peer-to-peer lending is gaining serious traction in Australia and all over the world for that matter. It's quickly becoming a favoured way to go about attaining business and personal loans as it cuts out the conventional institutions such as banks.

What is peer-to-peer lending?

In a nutshell, peer-to-peer lending is when an individual or business applies for a loan from private investors and this loan is facilitated by a third party. The third party is where the peer to peer facilitator comes in, in the form of an online platform. 

Okay, so how exactly does peer-to-peer lending work?

It works differently for the borrowers & the investors

With borrowers, when they are borrowing they will initially do so via a P2P platform, at which point all the regular loan approval checks are done, such as credit history, employment status and income. Should all criteria check out at this stage, and they’re successfully approved, they will be matched up with an investor. Interest rates are determined based on the borrower’s credit history.  

As far as investors are concerned, they are able to decide how much they are willing to invest and also the type of loan they wish to invest in. The P2P platform then matches like and like parties so that the loan is ideal for both borrower and investor.

How do investors know what they’re getting involved in? Well, they choose the level of risk they want to take on and can make an educated choice from there. 

P2P loan types & fees explained

The quick way to get answers to this question is to consider the fact that there are a couple options when going the P2P route for lending.

1. Secured or unsecured loans?

Secured loans are your best bet for lower interest rates as they are less risky for investors. The significant difference is the fact that secured loans require security in the form of an asset that can be used as collateral should the borrower default on the loan. Whereas, unsecured loans don’t.

2. Fixed or variable rate loans?

Again, in this case, if you choose a variable loan you get the advantage of a lower interest rate as well as access to additional features such as no penalties for additional or early repayments. That said, the benefits of a fixed rate include being able to budget accordingly without the risk of being hit with a rate that leaves you short of cash at the end of the month. This choice is all about preference as they both come with their respective pros and cons.

Fees for borrowers:

• Tailor-made rates – P2P lenders tailor their rate to suit your credit history
• Upfront fees – Usually comes in the form of Risk Assurance or even credit assistance
• Monthly fees – Loan management fees are common, look out for that
• Additional repayments – As mentioned before, with certain interest rate choices, you could be in for a penalty fee if you make additional repayments or early settlements 
• Maximum loan amount – P2P lenders have a smaller maximum loan amount than conventional banking institutions

Fees for Investors:

• Risk assurance fee – This fee protects the investor’s interest
• Lending fees – In some cases, P2P platforms will charge lenders an interest margin fee on the gross amount of interest received
• Tax returns – If the investor earns any return on the loan, it will be taxable

Peer-to-peer loan risks 

As with anything involving money, there are always risks involved.

When it comes to risks to a borrower, you need to ensure that you get the best interest rate, as you might be fooled into agreeing to a higher rate product by simple marketing. There are also hidden fees that you might not be prepared for that certainly need to be taken into account, such as the above mentioned, namely a loan management fee which P2P platforms tend to charge. Not having loan protection is a biggie, don’t get caught having major debt without protection should you have the misfortune of not being able to make repayments any longer.

For investors, it’s a little different, they are at the end of the carrot where financial losses are incurred if the borrower doesn’t make their repayments, and further to that, not having any fund protection means that should this happen, the investor would not be able to claim back for the losses incurred. Investors also only have access to their money once the loan term is over and that can be a setback should you wish to reinvest in something else.

Peer-to-peer lending regulations 

One thing to understand is that P2P investments are not protected by the Government Backed Guarantee on Deposits. However, with peer-to-peer loans, you needn’t be concerned with credit scores and background checks as they are performed by this ever-growing platform for lending. It is absolutely a priority for them to ensure the security of these loans and ultimately satisfaction for both investors and borrowers.

Pros & cons of P2P lending

Borrowers pros – Simple online loan applications and lower interest rates

Borrowers cons – Maximum loan amounts are smaller than offered by traditional lending institutions

Investors pros – Allows you to personally select the borrower you wish to invest in and you are able to avoid the banks

Investors cons – There is no Government Backed Guarantee on Deposits