Does Peer to Peer Lending Offer a Promising Future as an Early Stage Investment Source?
Just over 14 years ago, peer to peer lending became legal in the UK, with the first peer to peer website being set up in 2005. While this sounds a bit like computers talking to each other, it is actually a way for many people to side step the banks for early stage investment.
By June 2012, the top three peer-to-peer companies in the UK - RateSetter, Zopa, and FundingCircle - had issued over £250 million of loans. In 2014 alone, they issued over £700 million. In 2012, the UK government invested £20 million into British businesses via peer to peer lenders.
As with any new lending or investing venue, there were growing pains that caused different results than those that were expected.
What Attracted Lenders
Peer to peer lending is a simple concept that involves the use of other people's money by those needing to establish a loan. The reason it was attractive in the first place was the return on the money loaned was substantially better than could be expected from a savings account or investment of funds in stocks.
Companies that sprung up to be the caretakers of this funding promised to be the watchdogs, do the credit checks, and make peer to peer lending safe for those who chose to invest or save in it. In the early phases, things did not work out well through some of these companies.
What Actually Happened
Many of the earlier firms that dealt out the money to borrowers did not concern themselves enough with credit checks on those requesting the money. Unlike banks, they took those who were higher risks, and many defaulted on their loans.
Although the interest rates on the loans were attractive to lenders, they were markedly lower than what the borrowers were paying to credit card companies. This is why peer to peer lending was interesting to borrowers.
The companies that were more conservative took the banks' lead and looked into the credit history of those requesting loans. Instead of maintaining standard rates for everyone who wanted to borrow money, they based the rates on payment history and credit scores. Those with extremely low scores didn't get the money, so it was less risky.
Peer to peer lending was pictured as a way everyday people could help the little guy out while snubbing their noses at the big banks. That may have been the case in some instances, but it proved to be more popular with investors for wealthy families seeking a bigger return on assets and hedge funds.
How Well Does Peer to Peer Lending Work
After the early years, peer to peer lending began to undergo adjustments and lenders saw a reasonable return on their investments. Some borrowers still make up stories to get more sympathy or look more capable of repayment, but the checks and balances have improved so the defaults are greatly down from the inception of peer to peer lending.
Lenders have a choice as to where they want to use their money. It is tempting to take a 10% to 14% return for a loan that is not as secure as some others are, but that is the trade-off for the better return offered. More conservative lenders don't get the big buck returns, but they are more assured that they will get their money.
Even though peer to peer lending is in its infancy, it has already proven to be a way to earn a respectful return on money. Some investors are still waiting to see how well it will perform for another year or two.
The interest rates are bound to level out some before the growing pains of peer to peer lending run their course. Of course, those who wait may see a great drop in earning potential before they make a commitment.
From the borrower's side of the fence, peer to peer is a good avenue to pursue if there is a real necessity. The rates between credit cards and peer to peer lending are closer now than before, so it might not be advantageous to pay one debt to assume another.