Basics of peer-to-peer lending

In recent years, peer-to-peer (P2P) lending has become the poster child of the alternative finance industry. In a 2015 report Morgan Stanley predicted that such marketplace lending would command $150 billion to $490 billion globally by 2020. If the P2P phenomenon has escaped your attention, now might be a good time to take note.

WHAT IS IT?

P2P lending is the practice of lending money to individuals or businesses through online services that match lenders – investors – directly with borrowers, enabling both parties to circumvent traditional providers such as banks. Lenders typically achieve better rates of return, while borrowers – individuals and SMEs (small- to medium-sized enterprises) – get access to flexible and competitively priced loans.

WHAT’S THE RETURN?

For investors, the benefits are attractive. Being matched with a borrower can take anywhere from a few days to a few hours. And where a bank might typically earn under 2% on personal lending, P2P returns can be more than three times that. Anthony Nantes, CEO of Australian P2P pioneer DirectMoney, says that while their investors fall into two distinct groups – retirees (or those close to retirement) and high net worth middle-aged professionals – they share a characteristic: “They are drawn to a better model of finance, and the attraction of a consistent income stream in the 7–8% range.”

WHAT’S THE RISK?

The key word here is ‘default’. When a borrower defaults on repayments for any reason, there is no government backing in place, as is the case with larger banks and institutions, so some or all of your investment could be lost. Relative to other financial products, the potential returns are significant, but as always the risks should be carefully considered.