With banks tightening loan criteria, borrowers are turning to the internet marketplace where the interest rates are reasonable and both parties get an acceptable deal.
Peer-to-peer lending grows in popularity
With banks tightening loan criteria, borrowers are turning to the internet marketplace where the interest rates are reasonable and both parties get an acceptable deal, writes Saleha Way
Back in 2007, bank-loan officers would fall over backwards to lend you money. Then came the credit crunch of 2008.
Fast-forward to today and the UK economy is struggling to recover, fuel costs are going through the roof, and jobs are disappearing fast. Christmas never comes cheap, but this year it will be particularly burdensome.
Now, when financial help is needed most, even the credit-worthy Briton with a steady job is turned down for a modest loan or slapped with a punishing rate if it is approved. On the flip side, savers find that they are losing money in real terms, with interest on their accounts earning an average of 2.8 per cent, below the rate of inflation, which recently has been stubbornly hovering at 3.3 per cent.
It is no surprise that business is booming for peer-to-peer (P2P) lending networks, the internet marketplaces where borrowers are matched directly with individual lenders. With no middleman to jack up the costs, and reasonable rates that are agreed mutually, both parties get a better deal.
Ian Ellis needed to borrow £2,000 (Dh11,555) after his water heater packed up in the recent cold snap. "It was a small loan and the bank rate was just too exorbitant," says Mr Ellis, who changed his name for this article for privacy reasons. "Then a friend told me about P2P websites. I found one, and from there everything was just so easy and pleasant. And because I've got a good credit rating, my interest rate is just way, way below what the bank was offering."
P2P, or social lending, is not a new concept. It was launched in the UK in 2005 by Zopa. But it was only when the global recession shook the banking industry in 2008, and with it the world economy, that business started to grow. This was further boosted by a government clamp down on Payment Protection Insurance, a big earner for banks and foisted on borrowers in case of sickness or redundancy. But exclusion clauses in the agreement usually meant that the premiums paid were worthless.
Zopa has half a million members and total lending of about £110 million. Giles Andrews, Zopa's co-founder and chief executive, expects the P2P share of the UK lending market to continue growing.
"As awareness of the distinct advantages it can offer over conventional banks widens, there is no reason why it cannot take very significant market share in time. Zopa already accounts for 1 per cent of the total unsecured personal loan market in the UK as just one provider, so the sky is the limit really," says Mr Giles.
Over the past year, Zopa lenders have enjoyed an average return of 8.2 per cent before bad debts, while borrowers pay an average of 9.1 per cent for a five-year loan. As a comparison, the same loan would cost Halifax or Bank of Scotland customers 19.9 per cent, and 16.9 per cent for HSBC customers.
Zopa was the first P2P network in the world, a great British achievement in the dotcom world dominated by the US. Its success has spawned a host of other sites worldwide. In the UK, four P2P lending sites have cropped up, all within the past six months: Ratesetter, Yes-secure, Quakle and Funding Circle, the first venture to cater to small businesses.
At Zopa, lenders set their own interest rates and are matched with appropriate borrowers, who are classed into five risk types: A*, A, B, C and Young, for borrowers aged from 20 to 25. To reduce the risk for lenders, each loan is split between borrowers. For example, lenders offering more than £500 will have their money spread over 50 borrowers.
The amount individuals can borrow, and the term of the loan, differ from site to site, with an upper limit of £25,000 for individual borrowers and £50,000 for business at Funding Circle. The companies make money by charging lenders and borrowers a fee, which varies from one company to the next.
But whatever system they use and fee they charge, the one thing they have in common is strong risk controls. All borrowers must be over 18 and live in the UK. They are then credit-checked and graded. Those with a blemished credit history are offered higher rates or turned down altogether. At Zopa, affordability factors are also checked.
"We assess the person, rather than the project," says Mr Andrews. This means more than 75 per cent of borrowers who apply get turned down and Zopa is able to maintain a default rate of only 0.7 per cent, the lowest on any personal loan book in the country.
It is the default rate that has tainted P2P lending in the US, after one company had too many sub-prime borrowers on its books. When the recession hit, many borrowers failed to repay their loans, causing big losses to lenders.
Still, the risk to UK savers cannot be overestimated. P2P lending is an unregulated area and not covered by the Financial Services Compensation Scheme.
However, while P2P sites are mostly focused on attracting lenders with a promise of high returns, they are appealing to a new breed that could be described as "investors with a conscience".
Among them is Kim, a retired social worker. It is the more personal requests that attract Kim's attention - such as to pay for private cancer treatment, or to buy a caravan so children can have a holiday on a budget.
"Social lending could be one way for me to help people and make some money at the same time. I won't be greedy and ask for a huge interest rate, so the chances of me losing money are low," says Kim, who wishes to remain anonymous. "I will invest in the new year. It will be one of my 2011 resolutions."