Peer-to-peer lending involves risks for lenders and borrowers. Although fees charged by the websites are lower than those charged by banks, potential lenders and borrowers must understand the terms of the transactions.
Advantages and risks for lenders and borrowers
Peer-to-peer lending sites allow borrowers and lenders to come together without the expensive services of a bank. These websites allow lenders the possibility of earning high interest on funds lent, but there are risks involved. Borrower If a borrower defaults on a loan, there is likely to be a real loss for the lender because the sites are not subject to the strict regulation that applies to banks. The websites require a fee for each transaction, though this fee is not comparable in size to the fees charged by the banks. The fee charged to lenders is generally a percentage of the interest that they receive, while borrowers may be charged either a fixed amount or a percentage of the interest paid. Lender The lender should look carefully at how the site screens potential borrowers to ensure that they are a satisfactory credit risk. The site should ideally look not just at the credit history of the potential borrower but at the amount that they want to borrow and their ability to pay this back.
Peer-to-peer lending websites
On some websites, such as Zopa, the lender may have a choice of the type of borrower and level of risk that can be taken on. In this case, lending to the higher risk end of the market will entitle the lender to a higher nominal interest rate.
However, if the lender is taking on a high level of risk, this could end up with a much lower return than anticipated. A site called RateSetter has a provision fund for bad debts, funded by charging borrowers an extra amount on top of their normal rate of interest.
A possibility offered by Funding Circle is for individuals to lend to small businesses. The businesses are checked thoroughly and must have at least two years of audited accounts. Lenders can set the interest rate that they want to receive and the funds will be channelled to those businesses that are prepared to borrow at that rate of interest.
Person-to-person lending sites Some person-to-person lending sites allow borrowers to explain why they need the funds, what they intend to do with them and the rate of interest that they are prepared to pay. Examples of such sites are Quakle and Yes-Secure. This information may be useful for the lender, depending on the extent to which the details supplied by the potential borrower are verified. The extent of verification may, however, be limited to checking the borrower’s credit score.