Understanding peer-to-peer business lending
For a relatively new industry, peer-to-peer business lending has certainly taken off. There are currently seven major players in the UK market with others emerging all the time, and while they operate in a similar fashion, each has its own lending criteria. For those who are risk averse, it’s good to know that the industry itself put out a call for regulation to the Financial Conduct Authority and that this regulation came into force in April 2014.
The Peer-To-Peer Finance Association has also been set up to promote high standards of conduct and protect consumers.
The origins of peer-to-peer business lending
When the recession hit, many banks in the UK and USA pulled out of lending, making it difficult for existing businesses and those seeking start-up finance to get a foot on the ladder. Simultaneously, the collapse in deposit rates combined with a hike in credit card interest rates left businesses seeking alternative means of borrowing and investment.
Peer-to-peer lending filled this void by connecting borrowers and lenders via an online intermediary. Initially aimed at individuals and small businesses, some established peer-to-peer platforms now accept institutional investors, including banks.
How peer-to-peer business lending works
The concept behind peer-to-peer business lending is straightforward. You borrow money from a third-party at a lower interest rate than what the banks are offering. At the same time, lenders capitalise on low deposit rates by charging higher interest than what they would receive from the bank. The peer-to-peer lending provider connects the two via its website, and takes care of credit checks, repayments of the principal, interest payments, and chasing defaults.
The provider then charges fees to the lender and the borrower, and sometimes takes a cut of the repayments. Some providers allow lenders to list their loan requests online for investors to browse, effectively connecting the borrower and lender directly.
Rewards and risks for lenders
While the immediate benefit is earning higher rates than the banks will offer, there are also long term rewards for those lenders who wish to take tighter control of their investments. By building a portfolio of loans that mature at different times, many lenders are creating an on-going income stream that offers a reasonable level of security and lends itself to easy analysis. This money may be used to re-invest, supplement income, or create an independent lifestyle for the lender.
With most lenders offering unsecured loans, and some providers not offering a secured loan option, it can be difficult to attract borrowers willing to offer security. Also, as with any area where you’re lending money, defaults are inevitable. The best way around this is to build a default rate into the amount you are able to lend, so you can weather any surprises.
Rewards and risks for borrowers
As well as being able to borrow money at a lower interest rate than the bank, borrowers have the luxury of shopping around for lenders. The lending process is also uncomplicated, as it may only take a few days to secure your required amount from a lender, as opposed to the often gruelling process of obtaining a bank loan. Loans are often unsecured, bringing peace of mind, and there’s less fear of personal judgement, as all loans are based purely on financial and business information.
The only real risk to borrowers is that they won’t find a lender willing to invest. Many lenders prefer to invest in businesses that have been operating for over two years, although there are plenty of lenders with greater risk appetites.
If you’re unable to find a lender, there is always the option of adjusting the amount of finance sought. It could also be a good time to look at the feasibility of your idea or growth strategy. With so many investors and platforms out there, being turned down by all and sundry could be the wake-up call your business needs.
As always, your financial situation will be unique to your personal circumstances. In all cases, you are best advised to seek professional financial advice before borrowing or lending large sums of money.
Whatever your circumstances, Expert Wealth Management are well-placed to advise you on financial planning and investment management matters. Call us on 01993 772467 or contact us here to find out how we can help you.
