Looking for a new way to create some cash on the side? Peer to peer lending is one of the ways investors can loan money to other ‘peers’ in exchange for some interest. Businesses and consumers might not want to pay the interest rates of a bank and are looking for something a little bit cheaper.
This type of online marketplace can be a solution to many problems associated with traditional lending – although it’s not without its risks.
What is peer to peer lending?
Peer to peer lending is just what it sounds like, individuals lending money to other individuals. The practice also goes by the name marketplace lending, as people match to each through a website and lend money or actual products. There are generally 3 parties involved in the process.
- The investor
- The intermediary
- The borrower
The intermediary is usually the website which serves as the marketplace for the investors and borrowers. The website can then charge fees which it uses to make a profit as it acts as the financial services provider. The difference in peer to peer lending is that there is no bank or credit union which is providing the money instead it is individual investors. The idea behind this is to operate outside of the banking industry in order to get access to lower interest rates.
The benefits for investors is the possibility of making a profit through interest. Depending on the marketplace, investors may be given more control. As a result, an investor could create a portfolio of loans similar to having a share portfolio. Therefore, you could diversify your portfolio with some small safe loans and maybe a few riskier loans with higher interest for example. However, some marketplaces may not allow this and instead, you just select the amount to lend and it is automatically assigned to a borrower.
A borrower may enter the market because of lower interest rates compared to a bank or credit agency. Generally, the website should carry out a credit history check. It’s up to the website on whether they disclose this to investors. Hence, both the investor and the borrower should have their details remain confidential. The market may move towards blockchain which could allow peer to peer lending without a person in between. This could also be coupled with a smart contract for secure traceable lending. Nevertheless, as of now, there are certain legal requirements needed for the lending of money.
Risks of peer to peer lending
Peer to peer lending should be safe and secure. The law requires that the owner of the online marketplace must have an Australian Financial Services Licence. You can use the ASIC connect tool to check if the website has an AFS licence. A legitimate lending website should also have an Australian Registered Scheme Number (ASRN).
The risks an investor may face, fall into two camps:
- Borrower defaults
- Website fails
If a borrower can’t repay their loan, you need to know how you can get your money back. Then, who will recover the debt and if there an asset tied to the loan (secured loan). If the website goes bust you need to know what is going to happen to your portfolio of loans. In some cases, an investor may lose and recover nothing depending on the website as the investor bears the risk.
As a business or consumer, you should check your financial situation to see if you are capable of handling a loan. You should also make sure you receive a credit guide which will describe the complaint process and provide information about the website and how it works.
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