Peer to peer lending is an interesting way of raising capital for a venture
I was talking to a friend of mine last week when the conversation moved on to investments and how incredibly poor rates for money on deposit are and have been for years’ now and how the prospects for that to change any time soon were not good.
There wasn’t much of an alternative for people other than maybe buying property but that’s not for everyone and you would have to have quite a bit saved as well. So, nothing much on offer for people with smaller balances, they just had to suck it up and accept their return would barely match the rate of inflation.
He was smiling as I was saying this and after I finished talking, he said he remembers feeling that same frustration, but that all changed for him 18 months ago, when he made an investment of €10,000 which has been averaging a return of 10% every month since.
So, what product was giving him a return of 10% each month?
It wasn’t so much a product rather than a mechanism - a mechanism which brings together savers with money to lend in touch with individuals or small businesses that need to borrow money. And the idea is simple, in that both will benefit from better rates than each could get from financial institutions.
This concept is known as Peer to Peer Lending (P2P).
This activity has exploded in size since the first P2P, company, was established back in 2005. According to a study carried out recently by Cambridge University, about €26 billion is lent through P2P lenders each year, and this figure is only going to get bigger.
The reasons are easy to understand from the perspective of the saver and borrower.
There is c. €94 billion in household deposits in Ireland sitting in accounts earning an annual average rate of 0.18%, according to figures released by the ECB in March of this year. Fed up with earning such a terrible return, some people are looking at ways of increasing the return on some of their money, and lending to companies or individuals is one possible way of making that happen.
From a borrowers’ perspective, they are getting access to funds much quicker than they could get with a traditional bank. They are getting it at a better rate and, for many, peer to peer lending is giving them access to funds to expand that their bank simply would not.
The mechanics of lending money through a P2P company are simple: you choose who you wish to lend to from the companies applying for funding, you choose how much you wish to lend, and for how long.
What typically happens, if you didn’t want to lend money to one individual company, you can spread your risk by allocating your funds to a number of borrowers. For example a company borrowing €15,000 could have 150 lenders lending €100 each.
This is very important because it reduces your risk and exposure to loss. Because when you are lending money via P2P, the loans are unsecured and you could lose all or some of your money. There is no safety net of the government guarantee scheme which guarantees your savings up to the value of €100,000. This is the price, or risk, that savers pay for the higher rates on offer through P2P lending.
The comfort that lenders have is that the default rate lending via P2P is very low. In the UK, the default rate according to their Peer to Peer Association is 4.2%) and P2P providers advise that they carry out an extensive due diligence process on every potential borrower.
This includes the same credit checks a bank would do They also apply an excellent grading system to each company where you can see who they consider the strongest and therefore less risky companies.
One P2P lender in Ireland, Linked Finance, said time considerations and cost of credit are often the most attractive thing for their clients. It is also comforting to know that they will only accept companies that are at least two years old and won’t facilitate start-ups, and they reject over 45% of companies who apply to be included from the outset.
If you're interested, then your research. Look at the companies you are considering lending to, what expertise and background do the principles of the company have? Look at their website, what are your first impressions? What are they looking to do with your money?
Only lend the amount you can afford to lose and whilst the default rate on loans is very low be cautious nonetheless. A very good point was made by the Financial Compensation Authority (FCA) in the UK who said that some people who use P2P consider themselves “savers” whereas they are not, they are lenders and lending money can be a much higher risk than putting your money into a savings account, poor returns or not.
In theory P2P lending sounds very good, for all concerned, So this is what I am going to do.
I am going to start off with a small amount and I am going to give myself some time (six months) to see how I get on. I want to see the repayments coming in and I want to see how everything in reality works.
And if I can do my small bit and help support Irish Business and lend money to them whilst getting a good rate of return as well, then that’s good enough for me.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie