Peer-to-peer lending (frequently referred to as P2P lending), is a unique alternative investment platform that allows borrowers to skip over a financial intermediary, such as a bank, and borrow funds from an individual, or peer — hence the name.
This unique platform of investing is still relatively new, starting in the United Kingdom in 2005 and coming to the United States a year later in 2006.
Not even a decade old, this platform has grown and changed the lending landscape, effectively democratizing the playing field for borrowers and lenders.
Peer-to-peer lending in the United States started with the launch of Prosper, a San Francisco based P2P lending marketplace where borrowers can request loans of up to $35,000 and lenders can invest as little as $25 to get started. A number of peer-to-peer lending platforms including Funding Circle, RateSetter, and Zopa have launched since then, creating a robust peer-to-peer lending marketplace.
The Federal Reserve Bank of Cleveland recently distributed a report noting the positive aspects of the industry and the potential for increased growth. The report illustrated that in a short amount of time, peer-to-peer lending is seeing substantial growth in all areas. Global P2P lenders had a combined $3.5 billion in outstanding loans in 2013, compared to $1.2 billion at the end of 2012.
So why is P2P lending growing so rapidly? For one thing, the peer-to-peer lending interest rates are significantly lower compared to credit card interest rates.
In addition, the delinquency rates are lower for P2P loans compared to traditional consumer loans. Between 2010 and 2014, an average of 3.2% of P2P loans were past due, compared to 3.7% of more traditional consumer loans, like credit cards.
Although P2P lending is growing and proving to be an attractive alternative for borrowers and lenders alike, some investors are wary about the future of peer-to-peer lending and its long-term economic impact.
Recently Fitch Ratings, a global leader in credit ratings and research, released a report stating some concerns about the peer-to-peer lending industry and its future viability as an investment platform. Fitch Ratings is one of the main credit rating agencies and serves to assign credit ratings, which evaluate the likelihood of default and making payments on time. These ratings help inform investors and help them assess risk.
It is clear that Fitch believes peer-to-peer lending has a lot of potential, but they also have some concerns about the P2P industry.
Their main concerns are:
- Peer-to-peer lending has a limited history, therefore it’s difficult to evaluate its long-term viability
- Most loans have been acquired for debt consolidation purposes and have a risk of rising interest rates, which could adversely affect investors and borrowers alike
- Elevated regulatory risk — currently P2P lending is highly scrutinized
In the report, Fitch states;
“P2P lenders, as opposed to traditional banks, primarily act as intermediaries that collect fees from brokering loans between borrowers and lenders. The companies tend to be lightly capitalized and are exposed to high regulatory scrutiny. Fitch views the elevated regulatory, legislative and litigation risks, as well as the lack of prudential regulation (no minimum capital requirements) of P2P lenders as constraints that limit potential P2P ratings to below investment grade.”
Fitch’s concerns are in line with many concerns investors have as well. While peer-to-peer lending has seen an increase in recent years, it will be interesting to see how the trend continues to evolve and grow. Because P2P lending is so new, it’s hard to evaluate the long-term benefits and success of it, so investors should closely monitor their P2P lending investments to see where they are at.
As with any investment there is a level of risk that is part of the package, so decide for yourself if peer-to-peer lending is worth the risk to you.
Readers: Do you participate in peer-to-peer lending? What has been the outcome for you? If not, what are your hesitations?
This post was researched and written with the help of assistant editor, Melanie Lockert.