How does peer-to-peer lending work?
As the name suggests, peer-to-peer lending connects people who want to borrow money with people willing to lend money.
The aim is to cut out the middleman: banks use their customers’ money to finance loans and earn interest from that lending. P2P lending allows an individual to earn the interest instead, by offering loans directly to borrowers. The lender, AKA the investor, can choose the types of loan they want to fund.
On the borrower side, P2P loans work in pretty much the same way as any other. There can be slight differences in the application process: you usually list your needs and requirements on a P2P site, where investors can review and accept your borrowing request.
Overview of Peer-to-Peer Lending in New Zealand
Peer-to-peer lending in NZ is a relatively recent borrowing option that largely remains under the radar. There are a few key things to know before you dive into P2P lending.
Overview of the peer-to-peer lending market in New Zealand
In New Zealand, P2P lending platforms must be licensed. P2P lending is regulated by the Financial Markets Authority (FMA), and this regulation is more intense than you might assume. Some of the rules state that a borrower:
- Must provide honest information on how you’ll use the money and pay it back.
- Can borrow a maximum of $2 million in 12 months (and you must be able to service that level of borrowing).
Comparison with traditional financial institutions
How does borrowing through a P2P lending provider compare with borrowing through a traditional financial institution? Some key differences include:
- A different application process: The best way to describe the P2P application process versus bank borrowing is perhaps ‘personal’. You’ll be requesting the loan from individuals, so a more human, emotive request can sometimes work better.
- Different borrowing criteria: P2P lenders can focus on very different criteria to banks when considering who to lend to.
- More variance: With every P2P investor bringing different preferences and priorities to the table, you’ll see much more variance in P2P loans versus traditional loans.
Benefits of peer-to-peer lending for borrowers
When approached in the right way, peer-to-peer lending can bring several benefits for borrowers, including:
- Access to funds when you’re struggling to secure a loan with a traditional lender.
- Access to loans that lie beyond the lending criteria of major lenders.
- A greater variety of borrowing options.
What are the pitfalls of P2P lending?
P2P borrowing also has its share of potential pitfalls, which a borrower needs to be well aware of before committing to this type of loan:
- You’re at the mercy of lenders: If your request doesn’t resonate with investors, they can simply choose to deny funding, regardless of your ability to service the loan.
- You may face higher interest rates: P2P lending is generally a more expensive form of borrowing than working with a traditional financial institution.
- A lack of history: This is a comparatively new form of borrowing in NZ, so P2P platforms are still working to establish themselves. It can be tricky to know the safest option.
Conclusion
Ultimately P2P lending is best used as a backup borrowing option, when you are unable, for whatever reason, to enjoy the lower rates and greater security offered by a traditional lender.
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FAQs
What are the problems with peer-to-peer lending?
The main issue with P2P lending is that it can represent a more expensive way to borrow money, as individual investors look to mitigate risks and maximise returns. You’ll also be subject to the whims of those investors, so there’s no guarantee that you’ll be able to secure funding.
What is an example of a peer-to-peer loan?
While different P2P platforms take different approaches, here’s an example of how a peer-to-peer (P2P) loan process might work:
- You complete an online application
- You receive a credit assessment
- Your request gets listed on the platform
- Individual investors review
- When enough investors commit, an agreement is formed, and the funds are sent.