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Social lending has emerged as a popular alternative to traditional lending over the past few years. This gives both lenders and borrowers cause to celebrate! But what exactly is peer to peer lending? And what do peer to peer loans give you that other loans can’t?
Peer to Peer loans (also known as P2P) are based on the very simple concept of matching borrowers with lenders. Traditionally, banks hoarded savers cash, and made a certain amount of it available to lend to other customers. So although the idea isn’t new, cutting out the bank is. The availability of online peer to peer lending marketplaces make it possible to connect those who want to save with those who want to borrow – leaving the bank behind.
The benefits are obvious. An individual who deposits their money for lending can earn far higher interest on their savings than from a bank. Borrowers are also able to benefit from competitive lending rates. This is because social lending is far more efficient. A peer to peer lending platform does not have the same overheads as a bank. They also don’t take big risks on the markets with their customers’ money.
The principle of P2P loans is broadly the same, but most lenders work in slightly different ways to each other. So it’s worth spending some time reading up on how each individual peer to peer lender operates.
Generally speaking most peer to peer lenders will credit check potential borrowers. Some P2P lenders, however, will consider the overall circumstances of the borrower, to make a considered decision on whether to lend. Once accepted, borrowers are categorised into different levels. These categories will include how much they want to borrow, for how long, and their risk level. They are then matched with the most suitable lenders.
As with borrowers, most peer to peer lending platforms will ask the saver what type of risk they want to take, how much they want to lend, and for how long. To protect savers, the money is normally spread between different borrowers to minimise their risk. All parties normally remain anonymous to each other.
The main reason people are attracted to P2P lending, is the feel-good factor. The human side of lending and borrowing between individuals rather than through financial institutions appeals to borrowers and lenders alike.
As a practical solution, P2P borrowing is an option outside of traditional lending, and can be a cheap way to access credit. As with all loans, this is dependent on the applicant’s credit rating. Bad credit borrowers may have to pay more, but borrowers are normally allowed to pay off their loan early if desired. Lenders can additionally earn greater interest rates than putting the money in the bank. As mistrust for the traditional banking sector grows, peer to peer lending may soon overtake the banks as the most viable way to save and borrow.
There are a number of people who fear this strategy, and question whether or not P2P lending is safe. One question often asked is whether, as a lender, your savings are guaranteed and if your savings can be lost.
The Financial Services Compensation Scheme, guarantees a savers’ money that is deposited into a bank for up to £85,000. It also covers Investments for up to £50,000, however peer to peer lending is not covered by this.
Whilst it it true that not every business is going to be a success and not every individual will be able to repay their loan, if entrepreneurs and individuals do not have access to finance then our economy will not grow at the pace necessary to reduce the unemployment rate and deliver the jobs it so desperately needs.
The public sector has lost hundreds of thousands of jobs in recent years. These lost jobs will need to be filled by the private sector. And in order to create jobs, small and medium sized businesses need to be able to grow. Whilst the major banks do provide the vast majority of funding, they cannot possibly be expected to provide 100% of all the loans needed to help companies grow their businesses and create jobs.
Peer to peer companies have to ensure that the money that they lend out is given under the strictest conditions. If lenders have bad experiences they will tell their colleagues and peers, and in turn new lenders will be turned away. Their businesses can then fail. Zopa, the first peer to peer lender in the UK for individuals, has lent out over £280 million in loans, and has a default rate of 0.78%. Ratesetter, another peer to peer lender, who have lent out over £67 million in loans, have a default rate of 0.37%. Funding Circle, who only lend to small businesses, has lent out over £97 million in loans, has a slightly higher default rate at 1.6%. (Figures accurate as of July 2013)
One thing that is for sure is that the status quo needs to change. We only need to look at the global recession to understand how important it is that people invest, and the economy grows.