Five reasons why you should invest in peer to peer lending
Last week I got talking to the barista at the café downstairs from our office. He asked what company in the building I worked for, and then what Harmoney was.
He seemed intrigued at the idea of peer to peer at first… before balking at the average return on investment. You could almost see the Tui billboard in his head.
It’s the sort of too-good-to-be-true reaction we see from a lot of people when it comes to peer to peer lending. Part of it’s a general distrust of the financial industry, particularly any facet of it that seems too good to be true.
I’d be willing to bet that a considerable portion of those who read this are skeptics. I’d also be willing to bet that what follows will change your mind.
Peer to Peer Lending Delivers Compelling Returns
The peer to peer Lending model is about delivering better deals for borrowers and investors by lowering the cost of banking intermediation. Lending Club (the largest Peer to Peer Lending platform in the U.S.) uses 2.7% of the balance of outstanding loans to run their business, while typical banks use 7% of theirs (source). That’s a considerable difference.
Charles Moldow of Foundation Capital produced a fantastic report on the state of peer to peer lending recently. Check out this graph (right) that goes into greater detail of the cost advantage of peer to peer lending vs the banks, using Lending Club as an example.
How are peer to peer lending marketplaces able to operate at such low costs? They don’t have a branch network, instead operating through an entirely online platform. It’s a far more efficient solution, compared to the cost of running and staffing branches.
Check out Lending Club’s CEO, Renaud Laplanche, in an interview with Bloomberg TV , explaining how the platform is capable of delivering better deals than the banks.
We know what we’re doing.
Our team has been in the finance game for a while – 12 years, in fact. Our team successfully ran Pacific Retail Finance, exiting the company with over $3 billion in loan applications (half of which were approved), before moving on to a similar project in Australia.
We know what we’re doing when it comes to lending, we know who to lend to and who not to lend to, and we know how to assess credit risk. Our Chief Data Scientist was invited to speak at this years LendIt Conference in San Francisco – the world’s largest online lending conference – on the credit underwriting methods he has developed for Harmoney.
When borrowers are assessed for loan approval, the process isn’t as simple as being above or below a certain score. It’s a more complex analysis of the applicant’s credit behaviour.
Some peer to peer marketplaces restrict entry to borrowers below a certain credit grade – on Prosper and Lending Club (the two largest Peer to Peer Lending platforms in the U.S.) the average borrower FICO score is around 700 (above the U.S. average score, and generally considered good). Regardless of whether borrowers are restricted acceptance based on their credit score, the risk associated with their loan is made explicitly clear to investors.
On top of that, platforms that utilise fractionalisation in their model mitigate investor risk by only exposing a small portion of their investment to each loan.
Peer to Peer Lending Provides a Strong Addition to an Investor’s Portfolio
Peer to peer lending provides a good opportunity for investors to diversify their portfolio. No financial advisor will ever tell anyone that it’s a good idea to bet the whole farm on one pony. Diversifying savings across multiple models is smart. You shouldn’t have all your money in anything – banks, property, the sharemarket, or peer to peer lending.
If you’re keeping an eye out for a good opportunity to diversify your investment portfolio (which you should always be), peer to peer lending makes a strong addition for a multitude of reasons.
For one, it’s a model with fixed monthly returns and a low barrier to entry – with platforms that use fractionalisation, you don’t have to invest enough money to fund an entire loan, because loans are funded fractionally by multiple investors. At Harmoney, for example, you can start with an investment as small as $500.
For another, you have the opportunity to choose who you want to invest in – and ample information to make an educated decision on that front. This crucial point means that savvy investors have the opportunity to upgrade with effort and increase their returns, as it allows for interactive analysis and test to measure.
It’s Natural Selection
Why would you use stone when you’ve discovered bronze? Sit in the dark and freeze when you’ve discovered fire? It’s a little melodramatic, sure, but we're making a point: peer to peer pending is a natural evolution of banking.
Peter Renton mentioned in a recent blog that “consumer credit has been one of the highest returning asset classes for decades,” and it’s true – just look at banking profits.
Consumer credit is where the banks make most of their money – personal loans and credit cards are around 10x times more profitable than other areas of bank lending. Peer to peer lending opens up an asset class that the banks had previously kept to themselves – and for a reason, they’re milking it.
We’ve been paying for bank inefficiency for too long. The gap between interest rates for borrowers and returns for investors is huge. Peer to peer lending lowers the cost of banking intermediation, shrinking that gap with a model that’s more efficient and better meets the needs of the contemporary market, something the banks have had particular difficulty with.
“Customers want banks that are nimble, provocative and far more digital,” according to a recent U.S. study, and yet the top 4 U.S. banks were found in another to be among the 10 most hated brands.
Conversely, peer to peer has evolved in direct response to those needs. It’s a model capable of operating as a branchless, cloud based and fully automated system – which, besides resulting in lower operating costs and allowing better deals for both investors and borrowers, makes it a more convenient and responsive user experience.
It’s Just Not as Crazy as it Sounds
What’d you think when you first heard of peer to peer lending? Did you write it off, thinking it had to be incredibly risky, with massive default rates, because the quoted interest on investment was just too good to be true?
You wouldn’t be the only one to think that. But it’s not the case. If you do peer to peer lending right, it’s not overly risky. Default rates at Lending Club and Prosper are around the 3-4% mark. Zopa (the original Peer to Peer Lending platform) had default rate over the last 12 months of 0.09% – that’s astronomically low.
Add fractionalisation to the mix and the risk to investors is mitigated even further. Many peer to peer lending platforms utilise fractionalisation, including Harmoney. We split investor funds into $25 notes, which are then able to be spread across hundreds or even thousands of loans. By doing this, only small portions of an investment are exposed to risk, and the impact of a single default on the larger portfolio is minimal.
One of the biggest upsides for the New Zealand industry is that we’re regulated by the Financial Markets Authority. We can’t stress enough how important this is. New Zealand is one of the only markets to introduce regulation prior to the industry launching, which means that many of the teething issues other countries have faced are highly unlikely to happen here. All Peer to Peer Lending platforms will be licensed and regulated by the Financial Markets Authority, ensuring that they meet very strict and high standards. If you want to know more about the Financial Markets Conduct Act and what it means for peer to peer lending in New Zealand, the full legislation is available here.
There are a lot of problems with the banking system as it stands today. A lot of those problems stem from the fact that the banks don’t operate in the interests of their customers, but in the interests of their shareholders.
Sometimes, things seem too good to be true because they are.
But sometimes, the things that seem too good to be true have simply found a way to challenge the norm, and deliver a better result.
Peer to peer lending is the latter. It’s challenging the banks by operating on a model where the number one priority is delivering the best possible results for you.
Still a skeptic, or ready to join?