Peer-to-Peer Lending: Become Your Own Bank!

Lending

Peer-to-peer lending is a great example of why it’s an exciting time to be alive.

Technology is changing the way we live our lives and disrupting many old industries.

And it’s even happening in the finance industry.

These new ‘FinTechs’ as they’re called, are changing the way we borrow, shop, pay for things and even invest.

Change is the only constant as they say.  So it’s best to keep an eye out for possible investment opportunities.

And one thing caught my eye a while ago, peer-to-peer lending.

 

What exactly is peer-to-peer lending?

Well at the risk of sounding too simple, it’s exactly as it sounds.

Peer-to-Peer Lending is an online platform where borrowers and lenders are matched up, creating loans for an agreed period of time.

Think of it like a money match-maker!

It’s a lot like opening your own banking business, where you are lending your money to other people and businesses, receiving principal and interest payments in return.

The reason this technology is effective is, by creating an online platform, the peer-to-peer lending companies can operate at a much lower cost as they don’t have to rent large buildings and shopfronts filled with employees all over the cities, like banks do.

These cost savings mean lenders earn higher returns rather than having their money in the bank.  On the flip-side, borrowers can borrow at lower rates with more flexibility, compared to a traditional lender.

And the platform provider ‘clips the ticket’ on the way through and takes a fee out for matching the loans and doing credit checks on the borrowers.  So each party benefits as a result of this more efficient technology.

 

Why did we choose peer-to-peer lending?

After selling a property recently, we had a lump sum of cash that was destined for dividend-paying shares.

Although, we needed some of the money to live on and I was a bit wussy about throwing it into the sharemarket all at once.

We could have plonked it in our offset account and drip fed it into the sharemarket, but I thought I could optimise it a bit further.  By using peer-to-peer lending we could earn a much higher rate than we would if the cash just sat in our offset account.

We could also use the monthly payments to live on, invest regularly in LICs and give us more flexibility over when we offload our other properties.  Out of the growing number of these online platforms, I decided to go with RateSetter.

 

Why RateSetter?

For a start, they are one of the biggest peer-to-peer lending platforms in the world.  They started in the UK in 2009 and opened up for business in Australia in 2014.

Importantly, over that time-frame, not one lender has ever lost money.

Now, that doesn’t mean it’s a risk free investment or the returns are guaranteed.  But it does mean that they have a very good track record with managing risk and approving creditworthy borrowers.

RateSetter were also the first company to open their doors to all ‘Mum and Dad’ investors, letting us ‘retail’ investors in on the action.

Now anyone in Australia can get setup and start lending with only $10, which is excellent.  Some peer-to-peer lending companies are only open to the big end of town and high net worth investors.

After digging around their website, I was genuinely surprised and comforted by the transparency they provide.  There’s not much you can’t find on their website, but I still had some questions.  So I contacted them directly, asking them a ton of stuff on the ins and outs of the platform.

Staff were very patient and took the time to answer all my questions until I was satisfied, so the customer service was a big tick.

 

Provision Fund

RateSetter was the first peer-to-peer lending company globally to introduce the concept of a ‘Provision Fund’.

The Provision Fund works like a safety net.  As each loan is approved, the borrower is asked to pay a fee according to how risky they are deemed to be.  Then, basically the fee is popped into a big security bucket called the Provision Fund.

If and when some of the loans go into default (which is inevitable with any borrower/lender situation) then the Provision Fund kicks in to cover the loss and the lender receives their regular payment and will be none the wiser.

This is no guarantee, but again RateSetter has shown to be quite prudent and have plenty of coverage in the Provision Fund, helping to ensure every lender has received their principal and interest payments.

To my knowledge, they are the only Peer-to-Peer Lender in Australia with a Provision Fund in place to protect lenders.

 

Transparency

One of the things I like about RateSetter, is how open they are with their data.  Generally, what you see is what you get.

They make available mountains and mountains of statistics and data about loans matched, default rates, provision fund balance, amount lent, average age and income of borrowers and lenders.  You get the idea.

A lot of people are pretty untrusting of financial companies (sometimes for good reason), so it’s refreshing when a finance company is open and transparent.  If you like, check out their stats here.

 

Interest Rates for peer-to-peer lending

Now the fun bit.  Let’s look at how much we can make by becoming our own bank!

Here are the lending market rates as of 24/10/18.

 

As you can see, the interest rates are far better than the banks are offering on a term deposit.  It can be a pretty effective income stream for those on lower tax brackets.

The trade off is, that your money is tied up and you can’t access it.  It is lent out after all.

**Update – RateSetter have now made it possible to access your money early in case of emergency, for a fee of around 1.5%.  While the fee isn’t great, this is likely to prove popular with lenders who want that extra peace of mind knowing they can get the money back if needed.  You can find all the details here.**

Once the monthly repayments have been made by the borrower, they become available in your RateSetter holding account.

You then decide whether you reinvest some of it, all of it, or none.

*Special Signup Bonus for Strong Money Readers:  Use this link to get a $100 bonus when you invest $1000 (or more) in the 3 year market (or longer).

 

Who chooses the rate?

You do.  Well, the marketplace does.

You’re free to set your desired interest rate at whatever you’re happy to lend.  But your money will only be matched if a borrower is also happy to accept that rate.

Now that’s people power in action.  Borrowers and Lenders can scale up or down their desired rate they are happy to borrow/lend at.

Choose a rate too high and your money will just sit there.  By meeting the market at the going rate, your money will be lent out relatively quickly.  Currently, the lending rates are pretty appealing.  But rates could be lower in the future if more people choose to lend money on the platform and the supply of money pushes rates down.

 

Who am I lending to?

You will be lending to borrowers who have been approved by RateSetter and deemed creditworthy.  This could be individuals or businesses.

You don’t get to decide who you are lending to, which at first I wasn’t happy with.  But after a while I realised it’s probably better that way.

Honestly, I’d probably over-analyse the different borrowers and try to pick the least likely to default.  And it’s extremely unlikely I would do a better job than RateSetter.

But there is plenty still within your control though.  For example, you decide exactly how much you lend, the interest rate and how long you’re lending the money out for.

At any time, you can see the live dollar amounts of borrowers/lenders on the market.  (note – this is an old picture, the 1 year market is now closed)

 

Lending Markets

 

Concentration Risk

I was first concerned about the risk of having too much of my funds allocated to one loan, therefore perhaps being at a higher risk of losing money.

The first layer of protection is the relatively low default rates on the platform so far and the provision fund that is in place.  Secondly, you can choose to lend your money out in increments if this bothers you.

If you have $5k to invest, you can lend out $1k at a time.  And once you have been on the platform for a while, if you have reinvested any funds, you will end up having lots and lots of little loans.

This spreads your risk by being exposed to a diverse set of borrowers.  Of course there are other risks too, which RateSetter outlines for us here.

In particular, I’m interested to see how default rates hold up in a recession.  Please read about the risks and make sure you’re comfortable before diving in.

 

Extra Features

Recently, it was announced that RateSetter are opening up a new lending market on the platform called Green Loan.  This gives lenders the ability to choose to lend to borrowers who are seeking finance to purchase ‘Approved Green Products’.

These include solar panels, low emission vehicles, energy efficient lighting plus air conditioning and a range of other things.

Currently it appears the loans will be for 3-7 years and the interest rate for lenders looks to be around 6%.  The Greenie inside me is super excited about this option.  Supporting clean energy and making money at the same time is a match made in heaven!

 

Conclusion

There’s more I could go into but I will leave it there for now.  If there is anything you want to know more about, there is an abundance of information on the RateSetter website.

For anything else, give them a call.  I found them to be very helpful.  Our experience with peer-to-peer lending and RateSetter so far has been positive.

We have a decent amount invested on the platform and it works smoothly.  We’re receiving reliable monthly repayments and a pretty solid yield.

I can’t speak for the other platforms of course.  But RateSetter is easy to use, offers competitive rates, good transparency, flexibility, customer service and even a safety net in the Provision Fund.

It’s far from risk free, but I do believe it can play a part in an investment portfolio.  Remember, you can start with a tiny amount, see if you like it and go from there.  Starting a business with $10 is a nice option.  Especially one that will be earning positive income from day one!

One thing I will say is, it sure is nice to be on the other side of the banking table.  It’s nice to be the bank for once 🙂

So if you’re interested, you can open your very own lending business today!

 

*Special Signup Bonus for Strong Money Readers:  Use this link to get a $100 bonus when you invest $1000 (or more) in the 3 year market (or longer).  This blog receives a bonus too, so thanks in advance!  Full Ts&Cs here.  If you have any questions about Peer-to-Peer Lending or RateSetter, please leave a comment – I’m happy to help.  Note: the bonus is generally paid within 2 weeks after you invest. 

30 comments

  1. “…the Provision Fund kicks in to cover the loss and the lender receives their regular payment and will be none the wiser. … helping to ensure every lender has received their principal and interest payments. …”

    This is not quite accurate (unless they’ve changed the T&Cs since I read them) – the provision fund will cover your initial investment, but they will not cover any missed interest payments.

    1. When I spoke with them they told me how the defaults work. They explained the lender won’t know if a default has occurred, indeed defaults are already occurring and this is what happens. You won’t know anyone defaulted, you’ll receive your repayments as normal while they chase payment in the background.
      Please see the stats down the page here https://www.ratesetter.com.au/peer-to-peer-lending 100% capital and interest returned as due so far, remember this is despite the ongoing defaults.
      We are yet to see what happens in a catastrophic scenario where defaults are elevated though.

  2. Thanks for this summary. For whatever reason I have been hesitant to try this out but it seems like it could be a good option. I am going to look into it some more as we are selling one of our properties so would want to park some money somewhere for a bit. The 1 month option could be a way for me to dip my toes in so to speak.

    1. Glad it helped. It’s not without it’s risks of course, but it can be a good option for a multi-year timeframe versus an offset account.
      Good job on the property sale, we will be offloading one shortly too 🙂

  3. Hi Dave – can I ask what your approach has been with RateSetter? Are you doing just 3-year loans for example or have you mixed it up with different types? I also use RS and started off with 3-year loans only but I must admit I’m not crazy about a lot of the cash being untouchable for 3 years. I may start mixing it up with 1-year loans. Cheers

    1. Hi Scott. Yes, all funds are on loan for 3 years currently, haven’t tried anything else. 5 years was too long and 1 year was too short and lower return.

      I guess it comes down to whether you want the money in that time-frame or not. It’s suitable for cash you just want to tuck away for a few years, but keep in mind it gets paid back to you slowly every month, so the amount on loan reduces faster than you think, often with some early repayments as well.

  4. I’ve done some research into becoming a Ratesetter lender and after several phone calls (where I was worryingly given totally inaccurate information in the first 2 calls and finally asked to speak to another consultant) and reading the PDS, found that the interest rates displayed on the front of their website can at first glance, be misleading. With their 5 year rate it was quoted at the time to be 8.8%. To actually receive this annual return you have to reinvest not only the capital as it is repaid monthly, but also reinvest the interest component of the monthly payment. So if you want to draw an income stream and not reinvest the interest, the rate of return per annum reduces to 8.46% (according to Ratesetter’s modelling which was quoted to me – I couldn’t see it) providing also that your capital component of the repayments is reinvested at the same 8.8% perpetually with no lag time between uptake. Whew!

    1. Hi Danielle. Thanks for your comments and extra insights. I wondered similar things as you in the beginning. Now I tend to think of it this way…

      Your money will earn that rate for as long as it’s on loan for, which makes sense. As the loan is being repaid, naturally we receive less interest over time. To expect the dollar-value-return to remain the same, while having less and less invested on the platform wouldn’t make sense.

      But the lower interest payments for drawing an income are slightly confusing though. Would like to read any reference to this if you have one? That could be the monthly reinvestment lag you mentioned or something else.

      I kinda feel the lag time is of little importance. I mean, it often only takes a day or two to get a loan established. Don’t know about you, but I’m not really bothered working out 1 or 2 days worth of interest 🙂

      Even if rates were 1% lower than they are currently, in my view, it’s still an attractive parking spot for short-term cash – albeit not without risk.

      1. Yes I found the interest rates confusing, hence my many calls to Ratesetter. On page 31 and 32 of their PDS it states the part about reinvesting both capital and interest components of monthly payments to achieve the rate listed on the website. This condition applies to the 1 month, 3yr, 5yr and green loans. Curiously the 1 year term does not require you to reinvest the interest to achieve the quoted rate of return.

        As my focus for using the platform was to boost the interest rate of return on some “parked” money but we wanted a regular income stream from it as well, this was an important discovery to make before we take the plunge.

        I agree with you about the small lag times not making much difference and only referred to that for the purposes of being thorough and covering all the bases. Same goes for the mention of variation in interest rates of the reinvested money because they seem to be staying quite stable.

        1. Thanks for the reply. Hmm that’s certainly interesting. Maybe something to do with the 1 year rate being exactly 1 year, so there is no alternate outcome perhaps.

          Yes the rates are surprisingly stable. I was expecting rates to go down by now, as more money/investors join the platform. But it seems to have been met with strong demand from borrowers as well, causing interest rates to be roughly the same. Be interesting to watch it over time too.

          I notice the UK RateSetter platform has significantly lower interest rates – the 5 year rate is 3.8%, versus ours of 8.8%. Even considering official interest rates are 0.5% there, versus our RBA cash rate of 1.5%, that’s still a huge difference.

  5. Hey dave, if i lend 1000 for 5 years at 9.4% (which it is currently if you lend for 5) does this make it $94 per month for 60 months

    So 94 x 60 = 5640 will return over 5 years?

    How much did you put in to test the water?

    1. Hi Andy, no that’s not quite correct. The 9.4% is the annualised rate, meaning you’d receive $94 interest for the year, plus your principal returned back to you in monthly increments. If you let the payments come in and don’t reinvest the money, the interest paid to you will reduce over time as your loan balance reduces, so the return will be less than a constant 9.4% because you have less funds on loan over time.

      We had a six figure investment on the platform but it has now reduced to a five figure investment as we’ve been buying some shares recently 🙂

        1. Well no guarantees of course, but it should certainly help given it will be distributed among more borrowers that way. The provision fund has covered all losses since the beginning so that’s a good sign, but lending in smaller parcels could also help.

          1. So my 1000 just matched for 3 years @ 7.5%

            So 75 profit per year and get back $27 per month.

            When the capital and principal comes in per month and i have it set to reinvest to a 3 year loan, does it only put a small amount on? Is this a pointless way to do it?

          2. Nice work Andrew. There’s no wrong way of doing it, you can set it to grow with its own earnings (as you have setup) or you can add more – up to you. The payments will be relatively small because it’s a small balance, just as you’d get very small amounts of interest from a bank account for the same deposit. Get a feel for it first and you can always add more later if you enjoy the platform 🙂

  6. Dave:
    Another great article thank you
    I started checking out Ratesetter fairly closely and went in and had a look at the current stats
    “In Defaults” are now 404, “Hardships” 163 and “30 day lates” are 562 so maybe they have softened their borrower checks to gain market share

    Regards Rob

    1. Thanks Rob, good question.

      The number of defaults doesn’t worry me in the slightest. I expect the number to increase over time simply because more and more people will be using the platform. Just like the number of people defaulting on mortgages over time will grow simply because population growth means more people have mortgages.

      What’s far more important is the percentage of defaults and the level of coverage in the provision fund. And still the estimated default rate is relatively low at under 4% and is covered 1.6 times by the provision fund – still not a single dollar of payments to lenders has been missed. It probably won’t always be this good but it seems Ratesetter are still doing a good job of managing credit and the provision fund.

      1. Thanks for the informed reply Dave

        I am not aware what an acceptable rate of defaults would be but if near 4% is acceptable then I guess that is ok and if no lenders have actually lost money then that is good

        Yes their statistics are readily available and with lots of data – I would hate to try to get similar information from the big banks

        Regards Rob

        1. Haha yes the bank don’t like to share much do they?

          Going back to 2010 in the UK where Ratesetter started, lenders have received every payment owing to them including interest. I’m sure defaults would increase in a recession, but the provision fund will go a long way to plugging that gap (perhaps cover it entirely) – that’s certainly what Ratesetter are aiming for. Will be interesting to see how it all goes. Thanks Rob.

  7. Dave – you might want to update this article. RateSetter does allow an early withdrawal now but there’s a penalty for doing so. At least it’s good to know that you can get most of it back. I’ve been draining down our accounts lately and don’t think I’ll continue using it. I’d rather have the cash somewhere else. Scott

    1. Oh good spotting – I totally forgot! Will get it updated shortly, thanks! Good to know the option is there in case of emergency.

  8. I’m trying to weigh up weather to invest in VAS index funds or Ratesetter 5 year income. Which offers a higher return?

    1. Hi Dennis. Impossible to tell right now as we don’t know what the sharemarket will do over that time. If you’re in a medium to high tax bracket you may be more suited to buying shares as they’re more tax efficient, but obviously returns are much more uncertain in the short term compared to RateSetter. You could always do a bit of both if you can’t decide! Hope that helps.

  9. Really useful article – thanks! I’m looking into RS and one thing that confused me was the ‘borrower fee’.

    From the PDS: ‘In addition, RateSetter will earn $2,099.75 from borrower fees from each $50,000 investment which you lend via the RateSetter Lending Platform. This is paid by the borrower or series of borrowers in connection with loans to which your funds are matched.’

    This states that the borrower pays the fee, but the ~$2k figure is subsequently included in the overall fees listed in the PDS, so presumably it comes out of the principal you loan, therefore making it a fee you technically pay?

    If I understand it correctly and the borrower fee is being deducted from your money (either principal investment or earnings), that seems like a fairly large cost to bear. Do you just overlook this because it’s offset by decent returns? Or am I on the wrong track completely?

    Really appreciate any advice – thanks!

    1. Thanks Alex! The important thing to note is all investment returns Ratesetter quotes on the platform are shown AFTER fees.

      The ‘borrower fee’ you mentioned is charged to the borrowers which is essentially admin fees across the life of the loan and doesn’t affect what lenders (that’s us) receive. My bet is they’ve listed it there to be fully transparent as to what they earn from a loan overall, just like the interest margin fees are listed also. We don’t pay either of these directly as the rate we’re lending is already net of fees. Hope that makes sense 🙂

  10. Thanks for writing this article. I had dismissed P2P lending as being too risky, but this makes it seem really easy! I’m really keen to try it out now.

    1. Awesome, glad you found it helpful 🙂 Still risks of course, but I like that Ratesetter have the provision fund and a great track record.

  11. Hi Dave,
    Now with the current state of the economy, where do you see the likes of peer-to-peer lending like Ratesetter heading?
    One would anticipate higher number of defaults as incomes are lost.
    But on the other hand is there the potential for return interest rates to go up as more cautious people remove funds from ratesetter, i.e reducing the money loan pool?
    Interested to hear your views in current state.
    cheers

    1. Interesting question. We can’t be sure how it’ll play out, but I agree with you – higher defaults look likely and maybe higher rates too as people are less inclined to invest in the current environment.

      Here is a very useful update from Ratesetter on how they’re handling things and plans going forward. It’s good to see they’re proactive in managing risk/defaults and it’s comforting for investors.

      This is the first proper downturn that peer-to-peer lenders have faced and I’m keen to see how it pans out, but Ratesetter is arguably much better placed than most due to the provision fund and risk management. Hope that helps.

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