Peer-to-peer lending is a fast-growing way to borrow money – or to make a profit. How does it work? Is it safe? Is it a good investment?
Peer-to-peer (P2P) lending is the crowdfunding of the credit world. It’s a way for a person or company to lend money to another person or company – with no bank or other financial institution in the middle.
Although this sounds very direct, most P2P lending is done via a third-party platform. P2P lending platforms specialise in hooking up investors with borrowers.
This “matchmaking” is almost always online. Being able to match up borrowers and lenders through internet-based tech means that direct lending is far more practical than it used to be.
One of the draws of peer-to-peer lending is that it can offer good rates for the borrower and the lender. This is partly because of a lack of intermediary overheads.
P2P lending vs crowdfunding
Peer-to-peer lending is often mixed up with crowdfunding. On the face of it, they’re very similar: both use small amounts of money from lots of individuals.
It might be useful to think of crowdfunding as niche type of P2P lending.
Crowdfunding’s goals are much narrower than P2P lending. They are usually focused on new creative ventures, software or inventions.
Investors also get their returns in a different way. Instead of interest, crowdfunding contributors are rewarded with the product they’ve invested in. They may receive things like exclusive early releases, a mention in film credits, or even a personal meeting with an admired creator.
Who’s involved in P2P lending?
There are three main players in most P2P loans.
1. The Investor
The investor is the person or company lending the money.
They sign up to a P2P lending platform and deposit some money for investment. Often, they will be given a choice of risk levels.
2. The P2P Platform
This is the intermediary – the third-party middleman.
A P2P lending platform has several core functions:
- Matching up potential borrowers and lenders
- Checking out borrowers by:
- Carrying out credit checks
- Verifying identity
- Checking out lenders by:
- Carrying out anti-money laundering checks
- Processing repayments
- Collecting debt if necessary
Some platforms will split investors’ money and allocate it to many loans – usually after the investor says how much risk they are willing to take. Others will allow investors greater control over their loans.
3. The Borrower
The borrower is the person or company that needs a loan.
They will also sign up to the platform and apply for a loan. If they are successful, they will either be given a fixed offer or, on some platforms, receive different offers to pick from.
History of P2P lending
P2P loans are a recent phenomenon, but the concept has already evolved significantly.
When the idea caught on, it was seen as an alternative for people who struggled to get “normal” credit, or who wanted to replace their existing debt.
Zopa, the first P2P lending company, launched in the UK in 2005.
Zopa suffered a slow start, but its performance during the financial crisis (it saw no losses to investor capital) solidified its reputation. Damage to traditional banks was a further boost to the new financial tool.
The US market blossomed shortly after Zopa’s launch, with Lending Club and Prosper popping up in San Francisco in 2006.
In 2010, the industry saw another turning point, again in the UK. First came Funding Circle (August 2010), then RateSetter (October 2010) – both using the P2P model to lend to businesses.
Since then, peer-to-peer lending has become incredibly popular in many markets across the world.
The modern P2P market
The global value of peer-to-peer lending is projected to hit US$1trillion by 2025.
In 2015, the value stood at US$64billion. In 2012, it was just US$1.2billion.
This rapid growth can be put down to several things:
- Growing awareness of crowdlending
- Mistrust of traditional banks etc.
- More investors putting importance on transparency
P2P loan technology
The rise of P2P lending is due largely to its tech advantages.
Established banks are often tied to old, cumbersome methods of doing business. They have legacy systems which are updated to include modern practices.
New-era financial firms – ‘FinTech’ companies – have been able to design their businesses in the internet age. This not only means they can do their work faster, but it saves a lot of money on overheads. Having cloud-based infrastructure means far fewer replacement parts, specialist engineers and even rent.
When reading about P2P, you will often come across the word ‘FinTech’.
FinTech is short for Financial Technologies. It includes things like:
- P2P lending
- Mobile payments (Apple Pay, Google Pay)
- Crowdfunding (Kickstarter, IndieGogo)
- Money transfer services (PayPal, Venmo).
What these companies have in common is using technology to come up with new financial tools and products. They’re disrupting the traditional way of dealing with money.
One of the big jobs for a P2P lending platform is working out how reliable a borrower is. Will they repay their loan on time? Are they likely to default?
Up-to-date AI technology makes this data analysis much quicker. P2P lending platforms can often go from application to money transfer in 24 hours – much faster than a traditional bank.
P2P borrower statistics
Some groups are more likely to borrow money via crowdlending or other alternative lending methods.
Individuals vs business borrowers
Adroit Market research released a report that showed consumer lending dominating the market with a 72.2% share.
Consumer loans go to individuals – they’re used for things like car purchases, home renovations, student debt consolidation etc.
The average age of P2P borrowers varies hugely between countries and even individual websites. Overall, things seem to be surprisingly spread out between the generations – it’s not just Millennials jumping on the new way of borrowing.
- Bondora, a P2P platform in Finland, Spain and Estonia, reported an average borrower age of 44 (April 2018)
- LendingWorks, a UK website, say that around 75% of their borrowers are between 25 and 49
- Faircent, in India, draws a younger crowd – around 65% of their borrowers are between 20 and 35
P2P lending in Asia & Pacific
Outside of China, the Asia & Pacific market is still relatively small – with around US$1.1billion credit given in 2015.
China, even in the wake of the recent crackdown, is the world’s biggest P2P loan market. In 2015 (the year for which we have the most reliable data), the country saw US$100billion of new FinTech credit issued to consumers and businesses.
These figures came from the Asian Development Bank Institute (ADBI). They also noted that rapid growth led to a fragmented market with many small and medium-sized P2P platforms.
These companies gave a big section of society access to high-yield investments.
But the same platforms also, in many cases, took advantage of investors due to a lack of regulation. The government, it is thought, deliberately stayed out of things to encourage market growth. As a result, dodgy businesses – including Ponzi-like structures – were common.
Since 2015, the Chinese government has reversed its previous attitude and began to crack down on the P2P market. This has led to many businesses closing up shop.
As late as 2016, an estimated third of P2P lending businesses were considered problematic, but this is fast improving.
The ABDI says that China’s future success will depend on whether it can continue its trend in lessening risk while preserving widespread access to investments.
Another Asian country to watch is Japan, where P2P lending is largely focused on small business, rather than consumers.
Japan entered the game early – maneo was launched in 2008, just a year after the first ever P2P lending platform (in the UK).
The Japanese market is fast expanding – although its P2P credit levels are still just 2% of China’s, say the ABDI. The biggest P2P lending platforms in Japan are maneo, Inc.; AQUSH; SBI Social Lending Co; and Crowdfunding, Inc.
Japan, ahead of many other countries, began formally regulating crowdfunding in 2015.
P2P lending is dealt with under one of the less strict portions of the law, as it deals with small amounts of money. Plus, the government wants to promote its growth. But both investors and borrowers are well protected.
P2P lending in Europe
There isn’t yet an EU-wide regulation of P2P lending in place, although trade bodies support the idea.
Although Western Europe holds most of the P2P lending power at the moment, the region is swinging towards the East when it comes to alternative finance.
Mintos is the biggest non-UK P2P lender in Europe. It launched in Latvia and now has investors from over 70 countries. Unfortunately for the EU giant, it was recently refused regulatory approval in the UK. This drives a wedge between the continent and the birthplace of P2P lending.
Alternative lending is a big market in Germany, although strict regulations have slowed things down a bit.
The big P2P platforms include Auxmoney, Lendico and Zencap (acquired by Funding Circle in 2015).
Germany is much stricter on its P2P lending platforms than most countries are. It groups them, in many ways, with traditional banks. This has led to an entry barrier for platforms – they have to partner with established banks, that deal with the loan formalities.
The Nordic countries are also significant markets. Fellow Finance (Finland) is hitting milestones like record monthly loans (€18.5million in January).
Less optimistically, veteran Swedish platform Trustbuddy (launched in 2007) went under in 2015, and the reasons for its demise are still being picked through.
The UK is currently the biggest player in European P2P lending – not surprising, as it had a head start.
The “big three” P2P lenders in the UK are Zopa, Funding Circle and Rate Setter. Each has dealt with over £3billion in loans.
Most of the big P2P lending platforms are part of the peer2peer Finance Association (P2PFA), a group that enforces standards within the industry. Ratesetter is not part of this association.
In 2014, the Financial Conduct Authority (FCA) took charge of P2P lending.
The FCA are still tightening laws which, combined with general economic uncertainty in Britain, is rocking the boat.
In June 2019, the FCA announced new regulations to come into force December 2019. P2P lending platforms will have to restrict their investor marketing to a more exclusive target audience. They will also need to carry out ‘appropriateness assessments’ for borrowers which will assess suitability for a loan.
Investment and savings body Tisa released a guide for the platforms which explains ‘appropriateness tests’. It also says how to warn consumers if they’re looking for products which aren’t appropriate.
P2P lending in North America
P2P lending in Canada is regulated in the same way as securities. That means they have to register with the same regulators and abide by the same rules.
This has led to slower growth than in the US, but that’s not always a bad thing. A slow start can lead to greater stability in the long run.
The US is the world’s second-biggest P2P loan market. In 2015, US$34billion of FinTech credit was issued.
The US market is pretty stable and reliable. It functions well, and consumers are safe.
There is one big issue, though: a lack of competitiveness. Prosper and Lending Club dominate the market, and newcomers struggle. This in turn has led to less innovation than you might expect from a sector in the States.
Both the stability and the lack of new competition are due mainly to strict regulations.
As is the case with many things in the US, regulation of its P2P market is complicated and divvied up between several agencies.
- The Securities & Exchange Commission (SEC) looks after investing
- The Federal Trade Commission and the Consumer Financial Protection Bureau regulate borrowing
P2P lending platforms in the States do go through banks.
US law says that P2P platforms can’t give a loan straight from an investor to a borrower. This means that the platforms get loans from banks and then sell the debt to the lender.
On top of this, new entries to the market have high hurdles to jump. They must get State licences and register with the SEC (both of which are expensive, time-consuming challenges) and then report regularly to the agency.
Borrowing money with a peer-to-peer loan
Quick pros and cons
|Lower-interest loans in many cases||High chance of rejection if you have a low credit score|
|A chance to personally appeal to lenders||Possible lack of privacy|
|Separate from the big banks||Often lacks the same protection as traditional loans|
Process of getting a P2P loan
- Register online
To apply for a peer-to-peer loan, you’ll have to register with one of the P2P platforms.
- Fill in the forms
They will ask you for various details about things like income and debt. Be as honest as possible, as lying or being “generous with the truth” will come back to bite you later.
- What do you want to borrow?
You’ll specify how much money you want to borrow, and how long it will take you to pay it back.
- Acceptance or rejection
Applications are usually processed pretty quickly – that’s one of the advantages of going P2P. If you qualify for a loan, you’ll be shown:
- The amount of money you can borrow (note: this is sometimes less than you requested)
- The interest rates you’ll need to pay if you accept
Some platforms pool money from several lenders in each loan. Others may offer you more than one loan, from different investors, often at different rates.
Who can get a P2P loan?
All P2P platforms will require borrowers to be legal adults (18+ years old). Some raise this minimum age to 21, 25 or even older.
An important thing to bear in mind is that the credit rating calculated by a P2P platform might not be the same as the one your bank uses.
Most traditional banks go to the same credit referencing agencies for their information. But many P2P lending platforms have their own methods of calculating borrower risk.
They usually get some of their data from traditional agencies – but often they will add information like social media posts, identity card data, website interaction and employment records. This can seem like an unreasonable breach of privacy to many potential borrowers.
What are the interest rates like?
Often, it is possible for a borrower to pay back a loan with lower interest than they would if they borrowed from a bank.
As with all credit, borrowing rates will depend on circumstance.
Borrowers with good credit scores could easily get offers of low-interest loans (below 10% or even 5%). But those with poor credit rating could get stuck with high-interest loans – or they might be rejected entirely.
Some examples (using the latest available statistics from each platform):
- Auxmoney – Germany – 9.65% (date not specified)
- Lending Club – US –12.67% (q4 2018)
- RateSetter – UK 5.47% (2017)
- Faircent – India – 10.32% (2018)
Investing money in peer-to-peer lending
If you want to get started with P2P lending, you must prepare by researching the laws and regulations in your country.
In most places, there are then three main steps:
- Open an account with a P2P lending platform
You’ll choose this largely based on what kind of borrower you want – some platforms, as we’ve covered, specialise in consumer loans; others lend to small businesses.
- Set an interest rate or agree to an offered interest rate
This will depend on the platform you’re using.
- Lend money
Choose what period of time you’re willing to lend for (e.g. one year, three years, five years). Think about what level of risk you find acceptable.
You then either choose your own loans or use a site’s “autobid” tool, which will pick loans based on your parameters.
Can you make money through P2P lending?
Compared to most traditional forms of investment, P2P lending does well when it comes to average yield.
Some of the big players’ average returns are:
- Auxmoney – Germany – 5%
- Lending Club – US – 4.6%
- Ratesetter – UK – 4.6%
- Faircent – India – 17.46%
As you’ll see, it’s definitely possible to make money through P2P lending. Often, it will also surpass returns from other sources. However, it comes with a risk!
Is lending money via P2P safe?
It depends. The main factors are:
- The P2P platform
- The regulations it’s bound by
- The choices made by the investor
In many countries (e.g. the UK) P2P lending falls outside consumer protection laws which would normally act as a safety net for investors.
However, lots of places are tightening their regulations as they catch up with new, tech-based financial tools. China, for instance, is cracking down on P2P lenders after platforms enjoyed years in a Wild West marketplace.
That said, default rates in the UK and US are generally quite low – around 2%-9% is typical – and if a borrower does default, recovery of some money is often possible.
In some places, P2P lending is far riskier.
Anyone lending through a P2P platform should carefully read how the company manages risk levels.
- Some will be pickier than others when it comes to accepting loan applicants.
- Some will allow investors to spread their money between more loans (which means there’s less lost if one borrower defaults).
With that in mind, the things most likely to trip you up are:
1. Risk of default
One of the things that make P2P loans so popular – the possibility of credit for higher-risk borrowers such as small businesses – is also the factor that should make you mots cautious.
If a person or business can’t pay back the money you loaned them, it’s called “defaulting”. Check out the platform’s default rate (the percentage of borrowers who don’t pay back loans) for an idea of how risky their borrower pool is.
In many countries, the loans paid out through a P2P platform are not protected under the same consumer laws as most investments. In the UK, for instance, the FCA doesn’t include P2P loans under its Financial Services Compensation Scheme.
There are some ways to mitigate the risk of default. Some platforms offer a buyback guarantee, which means they’ll buy back your loan if your borrower is late with repayments. The length of time varies (usually between one and three months).
Some platforms also offer to make up the interest you’ve lost during this time – which ties into…
2. Risk of untimely payment
Lenders can’t predict exactly when they’ll get paid back.
If a loan is repaid very late, it has obvious consequences for any plans you had for the cash.
If it’s repaid very early, you’ll have missed out on interest – and you might not be able to lend it out at the same rate this time.
3. Risk of “money drag”
Money drag is when you’ve used an auto-invest tool, but it hasn’t found a suitable loan for you. That means your investment is sitting in the P2P platform not generating any interest.
This is not the most serious of the risks you’re looking at, but it has the potential to stunt profit. Keep an eye on your investments and change your loan criteria if you’re seeing too much money drag.
4. Risk of platform bankruptcy
This is the most worrying possibility. When financial companies go bankrupt, there are a lot of casualties – including people who invested through them. If the platform you’re dealing with goes under, you might lose all the money you’ve put in.
You can keep an eye on industry news to try and spot when a company is in trouble, but sometimes FinTech firms fold with no prior warning.
The best way to mitigate this risk is through diversification. That means not putting all your eggs in one basket. Invest your money in different ways, with only a portion going to P2P lending. Then, to be even safer, diversify within P2P. If you have (say) £10,000 to invest in P2P, you might consider putting £2,000 in five different platforms.
It may also be worth splitting your crowdfunding investments across different countries. Why? Because of risk Number 5…
5. Risk of external disaster
There are some things that spell disaster for any investment, let alone one in a relatively new market.
Political change is the least dramatic. If a new government changes the rules for P2P lending, platforms – and therefore your money – could suddenly be in trouble.
Next on the “argh” scale is economic crisis. Although some platforms saw through the credit crunch of the mid-00s, most were launched after the recession. How will they fare when the market crashes again? (And it is “when”, not “if – these things are cyclical).
Finally, we enter the realm of “acts of God” – wars, plagues, natural disasters and the like. These will make small investors’ returns seem unimportant to governments and the public alike. Your money would be at serious risk of vanishing.
Mitigating these risks also comes down to diversification, as well as keeping some of your money in easily-accessible, solid assets. Property is popular (it might lose all its value, but you’ll still have a roof over your head). So is gold. Cash is king, of course, but be wary of where you keep it – the Euro crisis saw some countries confiscate money from bank accounts.
Conclusion: what’s ahead for P2P lending?
Some things that could influence the future of P2P lending are:
- Economic uncertainty – the UK and US, in particular, may run into trouble here. While the industry came out of the 2007-09 recession, it was less weighed down by regulation and scrutiny than it is now.
- Regulatory changes – as P2P lending becomes more widespread and well known, governments will meddle more often. This could be a good thing in some regions and a bad thing in others.
- Bank perception – if traditional banks go through another round of terrible PR like the global financial crisis, we could easily see another boost to alternative finance
Signs of slipping?
Some of the major P2P loan markets are introducing harsher regulation – and that might stymie growth, at least while the wrinkles are ironed out.
China’s crackdown has so far closed thousands of the country’s P2P lenders, many of which were corrupt or straight-up fraudulent. But the new regulations will also hit the legitimate players. Lufax, one of the biggest FinTech companies in China, is now reportedly planning to leave the P2P lending sector.
Analysts are also seeing worrying signs in more venerable markets – although regulatory changes have been more gradual, their impact has been compounded by economic uncertainty. P2P lenders operate with very thin margins, meaning they’re unusually susceptible to market fluctuation.
Major UK player Funding Circle lost over £50million in 2018; and US firm Lending Club saw shares plunge over 85%.
Even more dramatically, Lendy, a P2P property finance firm, collapsed in May 2019. The failure has caused concern over peer-to-peer structure, as investors have been left uncertain of their rights. Lendy restructured in 2015, meaning some investors lent to the platform and others lent directly to peers.
The bright side
There’s a lot of good news alongside the bad. P2P firms across the world are hitting milestones and expanding as more people take an interest in alternative finance.
- UK FinTech hit record investment levels in 2018, netting £2.6billion
- Property Bridges, in Ireland, recently announced plans to expand across the whole country
- cash announced its one millionth financed loan in June 2019
Moves to the mainstream
Some platforms may try to stabilise their position by entering the “traditional” finance market. UK website Zopa, for instance, recently launched I an ISA– not strictly an ‘alternative finance’ product!
Banks on board
Although not quite mainstream, UK digital banks Monzo and Revolut are closer to traditional financing than most P2P platforms. But, perhaps sensing the rising tide, they’ve jumped on board.
Revolut partnered with Lending Circle in 2017; and Monzo made a deal with Zopa in 2018. Both banks now offer P2P lending via their partners.
Alternative finance is no exception to the trend towards globalisation. International platforms like Mintos are growing fast.
Cultural barriers are also being negotiated in forums like the UK/Turkey meeting last year where companies from both countries discussed ways to capitalise on Islamic FinTech.
Eventually, peer-to-peer finance is likely to settle into relative stability.
The ‘Wild West’ days are already behind us in most of the world. China’s crackdown signified the end of a runaway market of epic proportions. More economically conservative regions, like the US and Germany, could be the long-term model for P2P lending.