Property – alongside cash, bonds and shares – is one of the four most common types of investments.
Peer to peer lending
Maria Consulting LTD
Pasquale Laudonio
In the recent years I have been involved as Drupal Developer in a very new innovative financial sector: Peer to peer lending.
In this particular financial services, there are 2 type of users: Lenders and Borrowers. The principle is very simple: a Lender register to the web site to invest money which will be lent to people that are looking to borrow money. The Peer to peer lending company is like an intermediate that helps both users to achieve the following goals:
Lenders
Want a good return on their money
Peer to peer web site
Find a fair agreement that match both the Borrowers and Lenders expectation
Borrowers
Want cheap and affordable loans
Peer to peer lending Explained
In order to minimise the risk for the lenders, the Peer to peer web site lend the investor money on different loans having different interest rates: higher risk returns higher interest. Usually only 1% of the lender portfolio is invested on a loan so that the lender spread his risk over at least 100 different borrowers; The reason is very simple: DO NOT PUT YOUR EGGS IN A SINGLE BASKET as a borrower may default (with a very small probability) on the loan, the lender will still make a profit in the overall.
The loan with low risk (category A,B,C) usually usually offers interest rate up to 4-6% and they have a default rate less than 0.08%, as the rate goes higher (default rate also goes slightly higher such as 1% default rate for interest rates between 10-15%) the default rate may increase even up to to 10% for the highest level of risk which usually offer an unbelievable interest rate between 25% / 30%!
On average each Peer to peer lending web site that I know usually offers a product with an income guaranteed of at least 3.5% with any withdrawal fee, and more risky product that offers very good yields up to 7-8% per years on product that are exposed on more risky loans (with interest rate between 25% / 30%, but with default rate around 5-10%!). Each product satisfy the level of risk appetite of each lender.
A very simple example
Mister Smith
Invest £2,000
Peer to peer web site
Find and approve scrupulous 200 Borrowers that pass their risk criterial and allocate £10 on each loan. Before a loan is approved it has to pass a very strict credit, affordability check which it is done by an underwriter with the helps of fraud and credit agency which highlight the credibility of the borrower.
Borrowers
The system spread the risk over different risk categories and different terms. For example 120 loans are in the lower category (A,B), 60 on intermediate risk (C,D) and only 20 on the highest category(E) with an average interest rate around 11%, which will give after default a rate of around 6-7% depending on the loan book default rate (which usually is between 0.05-1%).
As you can see, the lender does not need to do anything: Only need to put money in and then wait for the repayments to start coming back each month. Interest also is repaid monthly so the lender can decide to re-invest each month all the returns
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All savings interest will be paid gross, ie, there'll be no tax taken off. This works for ALL interest - not just savings accounts, but bank accounts, credit unions & peer-to-peer savings. Basic 20% rate taxpayers can earn £1,000/yr interest tax-free. Higher 40% rate taxpayers can earn £500/yr interest tax-free.