Alternative Investment  

How do the different models vary?

This article is part of
Guide to crowdfunding and P2P lending

How do the different models vary?

Investors can get involved in peer-to-peer finance through one of two models: lending or investment.

The lending model means that investors can offer to lend to individuals, who might be looking to do home improvements or want a new car; they can lend to small businesses who may need the extra cashflow on a short-term basis or who want to invest in stock or capital expenditure.

An investor can also lend to property developers who need extra finance for their next project.

Investment crowdfunding is when an investor can buy equity or debt, and either sell it back to the borrower, or trade on the secondary market. Alternatively, if the borrower strikes lucky, and they have found the next James Dyson, they can sell if the company is openly traded.

The general principle is that an investor goes online and selects the type of loan they want to make, then the rate they are looking for, which usually determines the type of risk they are happy with.

The different platforms treat this in a variety of ways. If one is looking to lend to a business, then the website will automatically match the lender up with a potential borrower, based on their risk profile, and the borrower will offer details about their business model, their financial situation and reasons for needing the money.

For people lending to individuals, the borrowers tend to be more anonymous but are graded according to their creditworthiness, ranging from prime to sub-prime, done in a similar fashion to the banks.

Investors will see the creditworthiness of the people they are lending to. Models vary but Zopa, for instance, originally showed lenders the calibre of the people they were lending to.

Now, however, the loans are spread across a variety of risks, and the lender dictates the kind of loan rate they want to lend to and they end up investing in a portfolio of borrowers.

Finding a match

Ratesetter offers a slightly different model in that it operates by supply and demand.

John Battersby, head of communications at Ratesetter, says: "Let's say the market rate is 4 per cent and that's the last matched rate. I'm holding out for 4.2 per cent."

This lender would have to wait until demand has crept back up before people are prepared to pay more to get their loan.

"The market will find a supply and demand for the rate. If demand goes up and you get lots of creditworthy people needing loans you will get your higher rate.

"The matching is done automatically," he says.

An investor will go online and select from a number of different options the type of loan they want to invest in: typically these might be a one-year term, five-year term or a rolling term.