What is social lending?
Social lending sites (also known as peer to peer or p2p sites) were first launched in the UK in 2005 and provide borrowers and lenders a marketplace that cuts out the cost and hassles associated with more mainstream financial organisations. These sites connect individual lenders and borrowers online and when one person requests a loan the people that are willing to lend can all chip in to help lend the amount needed. No banks are involved, this is just a person to person arrangement (or in some cases person to small business)
Who do they lend to?
These sites lend to individuals who pass their credit checking system and the loans would typically be £1,000-£15,000 over a period up to a normal maximum of 5 years.
How do they work?
Borrower
- An individual wanting to borrow money will apply for a loan requesting the amount and the term required.
- A credit check will then be carried out and if everything is OK the loan will be arranged.
- On most sites there is a categorisation of borrowers depending on the perceived credit risk, this will effect the interest rate charged.
Lender
- An individual wanting to lend money can choose how much they want to lend, what term they want to lend over and what level of risk they are prepared to take.
- An individual can lend a very small amount (£10) or a larger amount (up to £25,000).
- Most sites manage the risk of default by spreading any individuals loan over a number of lenders, so if a borrower defaults no individual lender suffers the whole loss.
Who are the main players?
- Zopa -The largest social lending site with over 500,000 members, established in 2005.
- Quakle - Does not charge lenders but is smaller than many established sites
- Funding Circle - Concentrates on providing loans for small UK businesses.
- 'Yes-Secure' - Operates a bid system for its loans where borrowers submit their loan criteria and it is entered into an auction. Zopa offer a similar option.
- 'Rate-Setter' - Set up in 2010 and offers the option to lend money over a shorter term than other sites.
Pros
- As loans are arranged between individuals without the involvement of a banking institution there is potential for lower interest rates and fees for the borrower.
- Far cheaper than payday loan companies.
- They can be arranged quickly and simply and for small amounts that would be of no interest to institutional lenders.
- They provide lenders with an opportunity to obtain a greater interest rate on their money than they could get with a bank or building society.
Cons
- All loans are unsecured so any lender must be aware that defaults do occur and they can lose money.
- As these sites are fairly new there is no robust data on default rates available or how many loans are in arrears.
- At present, social lending sites are not regulated and therefore there are no common industry standards or an established complaints procedure if something goes wrong.
- As a lender, once a loan is agreed you are tied into the term of the loan or incur a charge if withdrawing early.
- Lenders do not receive the actual interest rate agreed with the borrower as the site will take their cut of around 1%.
- Borrowers have to pay an arrangement fee, typically £100-£150.
Would I use a social lending site?
Now there's two sides to this coin, there are borrowers and then there are lenders. From a borrower's point of what is there not to like? Interest rates on an unsecured loan lower than you will probably get from a bank. Magic!
But for lenders it's a different kettle of fish. The social (p2p) lending sites are on a major PR offensive. You will be hard pushed to find any negative comment on the internet about social lending, and if you do it's normally followed by a defensive comment from one of the businesses themselves
Most articles you will read about p2p lending normally centre around it being an alternative for savers seeking better returns than the miserly interest rate they are receiving on their deposit accounts. But let's be clear this is not an alternative to cash on deposit!!
For starters there is a risk with p2p lending that you could lose all of your initial investment should your borrowers default. With a bank account there is no such risk. The only risk of permanent loss of your money is if your bank went bust. But then your savings would be covered (or at least in part) by the Financial Services Compensation Scheme (FSCS).
In contrast, with p2p lending there is not only the prospect of the borrower defaulting but there is also the risk of the p2p company going bust. And if this happened then you would not be covered under the FSCS. In addition, it would then be up to you to chase the borrower for your money on your own. Not ideal.
Yes the social lending firms run credit checks and screening to minimise the risk of defaults but there is no guarantee that their risk assessment is reliable. So while you can chose the quality of the people you are lending to there is no guarantee that that they'll be as good as their profile suggests – partly because the credit check may not show all of the borrower's commitments. Also as stated above, for some of the newer p2p companies the advertised default rates are only indicative as they don't have sufficient data to provide a decent historical picture.
If savers wanted to take a bit more risk with their money, in the pursuit of improved returns, then they could take out a Stocks and Shares ISA. Not only would their money be accessible but the investment would be tax-free as well as covered under the FSCS.
My final concern relates to the charges that the p2p lenders levy. Which? Magazine recently criticised all the p2p lenders for the lack of clarity on their charges and minimum lending levels. But setting that to one side, obviously any fees are based on successful lending relationships being set-up and therein lies a problem for me. Call me cynical but how would a p2p lender increase it's profits? Arrange more loans is one answer and my concern is that in the long term could the pursuit of profit lead to a fall in the quality of the borrowers that they accept? That's pretty much what the banking sector did in the lead up to the credit crisis.
Don't get me wrong, there are a lot of satisfied lenders and borrowers using social lending (p2p) sites. If people use them with their eyes open then fair enough but I don't believe that most users really appreciate the risks they are taking with their money.
But to sum up, if you asked me 'would you lend money through them?' Then my answer would be 'I wouldn't even lend them your money!'.
So what are your thoughts and experiences on social lending sites. Please leave a comment below.
I like the social lending idea, mainly because it is a tool that takes a little power away from the banks. Let’s face it you can tak about losing some money because some lenders default on social lending sites but that amount would pale into insignificance when you compare to the amount being lost to us because of the reckless bank gambling on world markets and the subsequent ‘need’ to subsidise them.
On the losses front I know that Zopa has a much lower default rate than banks because it simply looks to avoid the reckless lending criteria of the banks. As the articles says, that may change in the future if profits are chased. However, with a low default rate and the fact that your money can be spread across many loans the risk that you will lose all of your money is pretty low indeed. Compare this to the bankrupting of the country by the banking system through its fractional reserve system. Social lending is not the creation of non-existent money to capture real money. It is the lending of real money to freal people.
BTW I am not an employee of a Social Lending company. I just hate the banks and what they have done. My advice to people is to get out of debt and stay there. Buy and consume what you need and can afford. Don’t allow the spivs and chancers to get the grip on you. I’m slowly doing and everyone else should too.