How peer to peer lending works

Peer to peer lending is a fairly new form of alternative finance.  Today we’re going back to basics to explain the mechanics behind people to business funding.

 

April was financial literacy month – or at least it was in the US, where financial literacy tests like this one from the Huffington Post were popping up everywhere.

Here in the UK we may not have a national reason to focus on financial education, but, just like in the US, there is a very real need to improve our collective understanding of how the banking system works, get to grips with the options that exist to help us manage our money well and generally improve financial decision making.

So, today, the FundingKnight blog is going back to basics and looking at just what peer to peer lending really is.

Put simply, it’s is a way for people to lend to each other – or businesses – without using the mainstream banking system to act as a middleman.  Removing that step in the process typically helps to reduce costs and so, often, peer to peer lending can deliver better rates for borrowers and better rates for lenders.

It is also a whole lot simpler than lending and borrowing through a bank and the fees and charges are more transparent on both sides of the lender / borrower transaction.

Why does peer to peer lending often offer good value? Why can it offer more transparency?

One answer to both questions is the small matter of spread, which brings us neatly back to where we began with financial literacy.

A spread is the difference between what a borrower pays and what the lender, or lenders, receive.

To visualise a simplified version of how the current UK banking system works, take a look at the diagram below:

diagram showing that interest rate spread is the difference between what a borrower pays and a lender receives

In this scenario, the bank takes a spread of 7%.

In reality, the actual spread taken by high street banks can be much larger. Towards the end of 2011, for example, peer to peer lender Zopa carried out research based on Moneyfacts data that showed that a typical Bank Spread was actually 11%.

What’s more, Zopa’s survey, carried out by Ipsos Mori, revealed that “93% of UK consumers aged 18 or over do not know what a ‘bank spread’ is and that even amongst those who thought they did know, less than half actually did.”

Unsurprisingly, many of the participants thought that a spread of 11% was rather high once the concept had been explained.

When it comes to P2PLending, things are a little bit more straightforward.  Here’s a diagram of how a marketplace run by a peer to peer lending service – such as Zopa for people to people lending or FundingKnight for people to business lending – might work:

diagram showing that peer to peer lending relies on transparent fees rather than taking a spread

In this case, both the borrower and lenders pay a fee that is clearly set out at the start and visible to both sides of the deal. Once that’s agreed to, interest passes directly from the borrower to the lenders that collectively get together to make up that loan.

The peer to peer lending service doesn’t take a spread and all of the interest rates that people pay or receive are transparent and freely available.

Of course, there are other issues to consider.  Peer to peer lending is not covered by FSA regulations and lending to others does raise the possibility of what would happen if they don’t repay their loan.

This is something good peer to peer lending services work hard to address, through rigorous credit checking, industry standard fraud checks and by encouraging lenders to spread their money amongst as many borrowers as possible to ‘spread their risk’.

Like everything, peer to peer lending is a personal choice that might be right for some and not for others, but when it comes to financial literacy, we think simplification and transparent fees and charges have got to be good news.

Photo credit – Used under Creative Commons Licence


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Interest? What Interest?

graph showing twenty years of base rate changesChoosing what is the best investment has become a whole lot harder since interest rates tumbled.  Now, most savers are on the look out for higher interest rates.  FundingKnight blogger Mark Harrison reflects on how at least one thing – the research process for finding the best savings and investments – has improved.

 

Getting at information has become a lot easier over my lifetime.

When I was a lad, there were two building societies on the local high street, and if you went in, you could queue up and discover what interest they paid.

At some point over the intervening years, the banks and building societies decided that they should ‘big it up’ a bit more, and started advertising their interest rates in their windows. (Of course, a lot of the building societies had turned into banks, but that’s another thought for another day.)

Now, if I walk around my local shopping centre, I see big numbers.

Well, big placards anyway.

The numbers themselves are small.

The Internet, of course, has really transformed information gathering. When I wanted to find out what the best interest rate on a deposit account was, I didn’t go down and look at the placards – I went to Google, which pointed me to http://www.money.co.uk/savings-accounts/all-savings-accounts.htm

According to them, the best rate I could get on my savings would be 4.7%. To do that, I’d need to head off to Scottish Widows Bank and commit my money for 5 years. Oh, and I’d have to pony up a minimum of £10,000.

If I was prepared to tie up my money for ‘only’ 3 years, the best I could do would be 4%. And at 2 years that comes down to 3.75%.

Whether you’re trying to build up savings for a future retirement (or, a rainy day), or actually trying to live on savings, the future is looking bleak.

To become a lender with FundingKnight, you don’t need £10,000 – you can start with as little as £500.

It’s not like a bank account, though – because you’re not paying for the huge infrastructure that high street banks spend billions maintaining – instead, you’re lending directly to British businesses. That’s why we’re able to offer our borrowers lower rates than the banks – but still ensure our lenders get rather more than 3.75%

Picture Credit

Why does Britain need people to business lending?

With savings and investments being eroded by inflation, we take a look at just why Britain needs peer to peer lending.

Since the crash of 2008, we’ve become used to headlines like this one from the Daily Mail telling the sorry tale of what’s happening to the nation’s savings…

“Savers lose £76bn in three years as interest rates are held at historic 0.5% low”

Picture of piggy bank

We understand why campaigns such as Save Our Savers are lobbying for a rise in interest rates, but we also know that many businesses are struggling to find competitive business finance and that rising interest rates could stifle their growth.

That’s why we think peer to business lending has such an important role to play in getting the British economy back on track and giving savers the rewards they deserve from their investments.

Peer to peer lending has been around for some time now.  You may have heard of Zopa, an online lending who lets people borrow directly from other people.

We think that’s a very good idea.  After all, stripping out the cost and complexity of the banking system can improve service and value for all. But we also think that we can improve upon the proposition a little bit.

FundingKnight doesn’t arrange loans between people but rather it matches lenders with healthy UK businesses who need additional finance to expand their already successful operations.

Lending directly to businesses through FundingKnight has several advantages.

Firstly, because there is so much more information available about businesses, it’s easier to understand their future prospects.

Secondly, because we’ve worked hard to develop a credit scoring system that includes all of the usual 3rd party checks as well as some more innovative developments of our own – created in conjunction with of the country’s finest academic minds on credit assessment – we know that we’re offering good deals.

Thirdly, because FundingKnight encourages you to spread your investment over multiple loans, you’ll be spreading your risk and maximising potential returns.

So, there you have three good reasons why investing in FundingKnight can make your money work harder.

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