What does Peer to Peer mean?

6 October 2016

Peer-to-peer (sometimes called P2P) lending is a fast-growing new way to borrow or invest money using the internet instead of a conventional bank. We explain what’s involved and how P2P is different to your average bank or finance company.

 

What is peer to peer lending?

Peer to peer lending uses the internet to match someone with money (a lender) to someone who wants to borrow money (a borrower). The loans are made in a marketplace and the company that organises the loans is the matching agent. The matching agent charges fees for facilitating the loan.

If a borrower’s loan is approved, it will be listed in the marketplace with their credit rating, interest rate and term. Lenders can then see the loan on the company’s website and choose to fund it. After a loan is funded the borrower receives their money. The borrower must then make regular repayments of principal and interest to the lender via the matching agent.

 

  • Lending is like a fixed-term investment. You deposit your money when you fund a loan and in exchange you receive repayments of principal and interest for the life of the loan.

 

  • Borrowing is similar to using a bank except it is often faster and easier to get a loan. Borrowers can use P2P for personal loans, business loans and mortgages. NZs' P2P companies let you borrow up to about $35,000 unsecured and up to $2,000,000 secured.

 

P2P can also be used to make currency transfers. Participants can agree to the exchange rate on offer or bid for a better rate. While banks usually charge fees and a large margin on top of the exchange rate, P2P currency transfers are made at the rate agreed by the two participants and have no bank margin loaded into the exchange rate, the marketplace will charge a fee for facilitating the transaction.

 

Example 1: Car loan

Bob wants to borrow $5,000 to buy a new van for his plumbing business. He uses a P2P website to apply for a 3-year loan with interest of 13%. Sally has $5,000 to invest. She sees Bob’s loan in the P2P marketplace and decides to fund his loan. Bob gets his $5,000 then makes monthly payments of $168.47 to Sally over 3 years.

 

Example 2: Currency transfer

Cleo wants to exchange New Zealand Dollars for £2,000 for her upcoming holiday. Rather than going to a bank, she uses a P2P currency website to make her transfer. Tony has £2,000 pounds to sell for New Zealand Dollars. He sees Cleo’s listing in the marketplace and agrees to the exchange at a rate of 1 NZD = 0.516949 GBP. Cleo gets £2,000 and Tony receives $3,870.

 

Do we have peer to peer marketplaces in NZ? 

Yes - New Zealand currently has registered P2P lending companies but no P2P currency transfer agents. There are four approved P2P loan and investment providers registered in NZ. These are Harmoney, Squirrel Money, LendMe and Lending Crowd. The first to launch was Harmoney in September 2014, closely followed by the other three in 2015. These companies are regulated by the Financial Market Conduct Act 2013.

Although there is no New Zealand based P2P currency transfer service, Kiwis can still use international services such as Currency Fair.

 

Is it safe to be a lender?

P2P investing (lending) carries risk like any other investment. However a P2P investment is fundamentally different than putting money into investment products in a bank or finance company. The process by which P2P providers facilitate a loan is as follows;

 

  • The credit worthiness of each borrower is assessed upon application, if appropriate they are given a credit rating and can list their loan.
  • Investors can assess the loan details, what the loan is going to be used for and the credit rating.
  • If an Investor decides to proceed they can split their investment by means of a technique called fractionalisation. Instead of investing the whole amount into one loan they have the ability to break down their investment into small chunks i.e. in Harmonys' case $25 chunks called 'notes'. Investors can partially fund many different loans hence spreading their risk.

The key point here is that the investor is not lending to a bank or institution for a return, they are lending to person who submitted the loan request i.e. they are being matched. However, in the case of a default in payment it will be the platform provider who chases the borrower to ensure they get on track with making their interest payments (not you the lender!). 

As mentioned above the New Zealand P2P participants provide secured and unsecured loans and all P2P providers allow loans to be paid off early without penalty fees.

 

Is peer to peer cheaper?

Yes it can be, for the following reason.

Doing a straight comparison of loan establishment charges P2P marketplaces are similar to other loan providers in the market (you can check out personal loan establishment fees on our personal loans page by clicking 'more details'). What makes P2P borrowing cheaper is the process of matching an investor to a borrower without the costs of a middleman. You borrow at a cheaper rate than you can get elsewhere and they invest at a better return than they can achieve elsewhere.

How do they do this?

They provide a marketplace (website) to manage all of the borrowing and investing activity over the internet, then make money via the volume of people using the site. Compare this to a bank which has to maintain an office and branch network and has significantly higher costs to run.

Remember P2P providers are not lending you the money, they are providing a place for the transaction to take place and they take a fee for providing the platform.

 

Pros and Cons

Pros

Easy to Execute

Lenders and borrowers can find one another efficiently without going to big banks. P2P lending is done online so it is fast. One NZ based P2P matching agent boasts that 99% of their loans are funded within 24 hours of being approved. There are no meetings or paperwork.

Easy to Access

For the borrower P2P lending has the additional benefits of being easy to access, particularly if you have been rejected for a loan from banks or finance companies. The Reserve Bank has stated that it does not intend to extend its LVR restrictions to P2P lenders, hence seeking finance this way may be an avenue for those who were unable to get a loan through traditional lenders.

Diversify Risk

For the lender P2P offers higher rates of return than banks, as always higher return means higher risk. However, loans can be fractionalised into smaller amounts so a lenders can partially fund many loans to different borrowers. This allows lenders to make several loans and diversify their investments.

 

Cons

Lack of Familiarity

P2P lending is a relatively new concept in New Zealand so is still not in the mainstream as a means of borrowing or investing, hence some people will be reluctant to try it out until it has been around for longer.

Direct Exposure to Borrower(s)

In a bank, loans are pooled together. A bank has the collateral to absorb defaults whereas individual lenders may not.

Early Repayment Risk

Currently there are no penalties for early repayment of loans, for a lender this represents a risk they will have to find a new investment should a loan be repaid early.