What is P2P lending?
Peer-to-peer lending comprises an online platform that connects an investor directly with a borrower, in return for a fee. Part of the alternative finance space, P2P platforms are competing with other lenders such as challenger banks and conventional banks.
P2P arose as an alternative to high-street banks, which due to their prescriptive lending criteria leave many consumers and businesses unable to obtain finance. The industry argues that rather than just taking the business the banks don’t want, it can provide more specialist finance solutions more quickly and sometimes more cheaply.
They can provide bumper returns for investors in the process.
Who is the typical borrower and lender?
Borrowers can be consumers, small businesses, property developers, or professional landlords, with various P2P platforms willing to service these different groups.
A typical P2P borrower might be a property developer seeking funding for a new housing project, or a business-owner who wants to expand into a new city. Equally, a borrower could be a friend or neighbour who needs money for a new car; to fund an academic qualification; or to pay for a wedding, for instance. If you need to borrow money for any reason, you could be a P2P borrower.
A lender is someone who has extra money to invest. They can be retail investors, family offices, sophisticated or high-net-worth investors, or institutions.
P2P lenders will usually have a diversified investment portfolio which contains a mix of equities, bonds and alternatives. Any P2P lending investment would fall under that ‘alternatives’ category. Alternative investments tend to offer higher returns than traditional investment options, but they can also come with added risk, so it is important to do your homework to ensure that P2P lending is suitable for you.
A P2P platform essentially connects borrowers with lenders so that everyone gets the financial outcome that they desire. Target returns will vary from platform to platform, so it is useful to shop around to ensure that you are working with a platform that best fits your needs.
How does P2P lending work?
P2P lending is the process by which money is transferred from a lender to a borrower. The borrower agrees to pay this money back over a fixed period of time, at a pre-agreed rate of interest (set by the platform). Lenders can receive these interest payments monthly, quarterly or annually. At the end of the loan term, the lender can expect to recoup their original investment, plus interest.
Some platforms allow lenders to choose the individual borrowers or projects that they want to invest in. This is sometimes known as manual lending. However, most P2P platforms offer ‘auto-investing’ services, where hundreds or thousands of similar loans are bundled together and each individual investment is spread across them all. By investing in a bundle of similar P2P loans, investors can add even more diversity to their portfolio and reduce the risk of losing a lot of money due to one failed investment.
What’s the attraction for investors?
There are several benefits to P2P lending. As previously mentioned, P2P lending can form part of a diversified investment portfolio. P2P lending also tends to offer relatively stable and competitive returns.
Research carried out by Peer2Peer Finance News over the past few years has found that year after year, regardless of economic downturns and pandemics, P2P lending has consistently delivered investor returns of between six and nine per cent. Many P2P lenders also enjoy the social impact of P2P lending, which allows them to finance projects which may not otherwise have the funding to get off the ground.
What’s the attraction for borrowers?
For borrowers, P2P lending can provide a funding option that may not otherwise exist. P2P platforms take their jobs very seriously and carry out intensive due diligence on any prospective borrower before greenlighting a new loan. While this is reassuring for lenders, who want to know that their loans have been properly vetted, it can also benefit borrowers who are not typical candidates for bank loans.
P2P platforms are run by financial experts and fintech veterans as well as specialists in the platform’s area of expertise. This can help them to recognise the potential in projects that a bank may dismiss as being too labour-intensive or too innovative. By hiring experts, many P2P platforms are also able to work alongside the borrower to ensure that their projects succeed and the loan is repaid on time and in full.
What are the risks?
The main risk of P2P lending is that the borrower is unable to repay the loan for some reason. This could cause them to miss a repayment, which is known as ‘going into arrears’. At this point, the P2P platform will usually intervene and speak to the borrower directly to offer support or to threaten recovery action. If the borrower has offered security on their loan (for example, in the form of a property or other asset), this security may be sold to help pay the debts. If there is absolutely no chance of recovering any money from a P2P loan, that loan is said to be in ‘default’.
All P2P platforms are required to demonstrate their process for handling loans in arrears, loans in recovery, and loans in default. If this information is not easily available on the platform’s website, it may be a sign that the platform is not regulated.
Every UK-based P2P lending platform is regulated by the Financial Conduct Authority (FCA). This means that they must comply with a strict set of rules created by the FCA to protect both borrowers and lenders from financial harm. You can check whether or not a P2P platform is regulated by checking the FCA register.
What sort of numbers are we talking about here?
Every platform runs a different model, so the sorts of loans – and returns – are varied. Depending on the platform, investments can range from anything from £10 to £50,000+ while loans can range from £1,000 to the low millions. Returns are typically around four to eight per cent but can be higher. Please note, that higher returns can often mean higher risks, so make sure you choose the right profile for your risk appetite.