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Taking control / 22nd May 2021

How Does Peer To Peer Lending Work?

How does peer-to-peer lending work?

Peer to peer lending has been offered by New Zealand banks since around 2014, but did exist before that. As a matter of fact, P2P lending has been operating in the US and the UK for more than a decade.

But what exactly is it? Here, we’re discussing the basics behind peer-to-peer lending; how it works, the risks involved, and the rules of engagement so that you can make informed financial decisions in the future.

What is it and how did it start?

In simple terms, P2P lending is borrowing from strangers. An online platform matches you with individuals who are willing to lend, and you receive funds from them, paying them back over time, typically with interest—just like a normal loan. Before, these platforms only provided personal loans for investment, but this has since expanded to business lending, also known as peer-to-business or ‘P2B’ lending. Some of the major platforms have even developed partnerships with banks.

There are two major business models on which P2P platforms work:

  • • Lenders or investors who give out loans to other people or the borrowers.
  • • Companies grant loans to their users (borrowers) in which other investors can invest.

P2P lending first came about in the year 2007 during the global financial crisis, as many investments became uncertain and unattractive, and confidence in financial instructions took a deep dive. Thus, traditional loans became much more challenging to acquire. P2P lending stepped into the gap, as a way for people to help each other recover, and slowly grew as an alternative means to borrow money.

How does it work?

In New Zealand, the banking system is operated by four big Australian-owned bank brands and their New Zealand affiliates. They pay interest to savers and charge borrowers a much higher interest rate. With P2P lending marketplaces, borrowers are connected to lenders, cutting the banks out of their intermediary position. Rather than borrowing from a bank, borrowers can take out unsecured loans with investors through the P2P lending platform. Investors, on the one hand, can get decent rates of interest by lending to verified borrowers.

What are the rules of P2P lending?

The Financial Markets Authority (FMA) imposed a set of rules for borrowers under the P2P lending business model. Here are some of them:

  • • Provide truthful information on how they will use the money and their capacity to pay it back.
  • • Borrow a maximum amount of $2 million in 12 months with some services allowing smaller loans.

Under the regulation of the FMA P2P lending platforms must:

  • • Be licensed to provide P2P lending services.
  • • Provide a platform for personal, charitable and small business loans.
  • • Comply with Fair Dealing obligation in the FMC Act.
  • • Have a written client agreement with lenders.
  • • Provide disclosure statements to retail lenders.
  • • Meet reporting obligations.

What are the risks with P2P lending?

Every investment poses some risks, and the same goes with peer-to-peer lending. On the borrowers’ side, there aren’t any huge risks. If your borrower application is approved, you have more chances to find an investor for your loan. However, missing repayments can hurt your credit rating and result in penalty fees.

On the other hand, if you’re a lender, a loan paid back early may mean smaller chances of earning interest from the loan. And if a borrower defaults on the loan, then you risk capital loss as an investor. The only advantage of taking that increased risk is that the returns are better than the interest you’d receive from investing your money in a bank term deposit or savings account, but this is a valid advantage, and it’s worth remembering that every investment carries risks.

Why do people choose P2P lending?

Online lending platforms operate more cheaply than traditional banks, offering competitive interest rates for borrowers. The platform also provides a faster application process. Lenders are keen on P2P lending because they can earn higher returns than they’d get with bank savings, and they can protect themselves by spreading their lending across multiple verified borrowers.

Get fast personal loans when you apply at MoneyShop

At MoneyShop, you can apply for a personal loan for as much as $20,000! We are a dependable lending service provider, and we’ve been trusted by Kiwis for over 28 years to help them reach their goals, by ensuring that our money lending process is designed to fit you. Apply for a fast personal loan today and we’ll get in touch!