P2P lending is a disruptive business model, which seeks to replace the loans function of traditional banks. In the UK, the P2P lending site Zopa surprised many by delivering large numbers of personal loans, which a much lower default rate than many banks.
In China, unregulated P2P lending was blamed for aggravating the damage of stock market crashes (many had invested with borrowed money from P2P sites). But the economy aside, is P2P a viable alternative to you as an investor?
What is P2P lending?
P2P lending, in its simplest sense, involves connecting willing borrowers with willing lenders over the Internet.
The typical P2P website lists various borrowers, along with some background details – depending on the site, borrowers could be start-ups looking for short term financing, individuals who want personal loans, or even Small to Medium Enterprises (SMEs) seeking bridging loans.
As a lender, you can create an account on the site to loan to one of these prospective borrowers. The interest rate is either fixed by the site, or worked out between you and the borrower. The site then acts as a middleman, facilitating the transfer of money. Some sites may also provide insurance for the lender.
In Singapore, the two leading P2P lending sites are MoolahSense and Capital Match. Both allow you to make loans to companies (not individuals). Capital Match projects returns that range between 15 to 25 per cent per annum for investors (lenders), while Moolah Sense aims to deliver around 21 per cent. The minimum investment is usually small ($1,000), and most loans do not exceed 12 months.
By contrast, it is a rare fixed deposit that generates returns of more than one per cent per annum. Most endowment policies and mutual funds project returns of five to seven per cent, if they are being realistic.
There is also a third option for P2P lending in Singapore, if you own precious metals such as silver or gold. Silver Bullion is a storage company and bullion dealer, that will let you use these as securities for a loan. Once you have stored your assets with them (they own a proper vault in the Chai Chee area), you can find a lender and borrow up to half the value of your assets. In the event you cannot make repayment, your assets will be sold to repay the lender.
This will appeal to P2P investors who are more risk averse – you will probably get a lower rate of return (around three per cent on average), but you know the loan is secured by the debtor’s gold or silver.
What is the upside of investing in P2P lending?
The main appeal of P2P lending is that returns are high, and the money is committed for short periods. It is not often that you can find an investment opportunity with double digit returns, of that frees up your money again so quickly.
Also, remember that P2P sites provide loan contracts. It is not similar to equities, where your returns will fluctuate based on the company’s performance – the company is obliged to repay you regardless of how well or poorly they’re doing. This is, in effect, a high-return, fixed income product.
In terms of risk, it should be pointed out that not just anyone can borrow*. The companies that ask for loans are thoroughly vetted -MoolahSense and Capital Match both have staff with extensive experience in credit and loans. It is quite well known, in Singapore’s small FinTech industry, that Capital Match approves less than 20 per cent of the companies that ask for loans.
(*Silver Bullion is the exception to this. There is no vetting because the loan is already secured – if your debtor defaults, their gold will simply be sold, and you will get your full repayment.)
What is the downside of P2P lending?
With regard to MoolahSense and Capital Match, it’s important to remember that you’re dealing with small companies, and taking it on faith that they will make repayments. There is no guarantee that defaults will not occur, nor is there any security in the event a default does happen. It is possible to lose the money you’ve loaned.
Silver Bullion does not carry this same risk. However, Silver Bullion will, as stated, mean much lower returns (unless you somehow persuade the borrower to accept a higher than normal interest rate for secured loans.) Also, borrowers who own large amounts of precious metals are not likely to be poor, so they probably have no need for small loans – you’d best have a lot of cash on hand if you want to lend to them.
There is also an added dimension of risk that comes from the P2P lending site itself. If the site closes down suddenly, it could cause havoc with existing deals between lenders and borrowers. To date this has not happened, and no one is clear on how debts will be resolved in such an event.
Who should consider investing in P2P loans?
It is best to treat P2P lending as an alternative investment, taking up no more than five per cent of your overall portfolio. Due to the high returns (often above 20 per cent) you could generate disproportionate rewards from a relatively small amount of risk.
As with any alternative, you must be psychologically prepared for a capital loss. If the thought of losing the money will keep you up at night, look for conventional options like bonds instead.
This article is contributed by Rohith Murthy who runs Singsaver.com.sg, a personal finance website dedicated to savings and smart credit choices. He has worked in the banking industry for more than 10 years, and believes that informed financial choices change lives.