P2P platforms can use similar ways to banks to assess the credit worthiness of a borrower.
For example, John Goodall, chief executive and co-founder of Landbay, says his company conducts ‘know your customer’ and ‘anti-money laundering’ checks on all borrowers, in addition to requesting copies of their bank statements and running their passport through the software platform Jumio.
He says this is in addition to instructing the Royal Institution of Chartered Surveyors to get valuation reports on the property and conducting full affordability assessments of the borrower’s ability to repay any mortgage.
With personal loans, Mr Goodall says these are most often used for debt consolidation, car purchases and home improvements.
Here, Mr Goodall says the borrower has no skin in the game other than their credit rating and as a result, default rates on personal loan platforms tend to be higher.
However, with business loans the lender is both dependent on the borrower and on the performance of their business. Mr Goodall says this is attractive because, like with equity crowdfunding, it allows investors to support independent businesses.
However, he warns that the risk of unsecured lending does still stand. Secured property lending comes in three main categories including development, bridging/commercial and buy-to-let.
Development lending is more akin to SME lending, according to Mr Goodall, as you are really depending on the success of the business backing the development than anything else.
If the borrower defaults before the project is complete, or if the property market moves significantly, the lender may be stuck with a half completed or unsold project with interest and fees continuing to capitalise.
Both bridging and commercial lending are secured, which helps with capital recovery in the case of a borrower default. However, Mr Goodall says these have both been historically quite volatile lending markets.
Online shopping, flexible working and all the other changes to daily life made possible by the internet mean that office blocks will start to have a noticeable drop in demand, Mr Goodall says.
He adds: “This is the key difference between commercial and residential lending; people will always need a roof over their head, but not necessarily a desk in an office or a high street shop.”
Neil Faulkner, co-founder of peer-to-peer lending risk-ratings agency 4thWay, says most platforms have so far been sticking to strict lending criteria.
Mr Faulkner says that is why most of the older, more established platforms have loss rates of less than 1.5 per cent a year and often closer to half that.
Newer, smaller platforms mostly have zero or virtually zero losses, he says, although this is possibly because it is easier to pick out the very best borrowers when you have less investor capital to deploy.
As with all investments, there are a number of potential risks, including:
• credit risk – the risk of a large number of defaults, especially during a financial crisis;
• concentration risk – the investor chooses not to spread across enough borrowers;
• interest rate risk – for variable-rate lending;
• platform risk – the risk that the P2P lending website will go out of business for any reason and it impacts the amount you get back, although most platforms are required to put protections in place to wind down loan books gently;
• liquidity risk – particularly when investors are fearful;
• currency risk – when investing in platforms operating in other currencies; and
• asset risk – when security valuations plummet.
There is also going to be systemic, regulatory, country/foreign investment and political risk, as well as volatility – albeit Mr Faulkner says to a far less degree than with the stock market.
Mr Faulkner adds that investors can gain access through certain funds and a small number of P2P lending investment trusts.
Manager Neil Woodford is taking positions in peer-to-peer lending, but there are some investment trusts that are focused exclusively on this new asset class.
Choices at the time this guide was produced are GLI Finance fund, P2P Global Investments, VPC Specialty Lending Investments and Ranger Direct Lending fund.
These funds both lend to borrowers through the peer-to-peer lending platforms and they also buy shares in the P2P lending companies themselves.
According to 4th Way’s Mr Faulkner they all tend to charge around 1 per cent management fees and 10 per cent to 20 per cent performance fees so they are not cheap. However, Mr Faulkner says lower cost versions are supposed to be on the way.
Some peer-to-peer lending platforms are already available for investment though Sipps and Mr Faulkner notes direct lending in Isas will arrive next year in the Innovative Finance Isa.
Mr Faulkner says the majority of platforms have secondary markets to allow investors to exit early.
Just like all other secondary markets, Mr Faulkner says investors can at times face liquidity problems, or they might have to accept less back than they paid in during periods when new investors are wary of investing.
