Have you ever wondered how peer to peer lenders like RateSetter actually work?
In this review blog I will take a closer look at what it means to be a lender and borrower on the RateSetter platform in Australia.
What is Peer to Peer Lending?
Peer to peer lending (P2P) is the process of using technology to match lenders directly with borrowers.
Since the peer-to-peer lending companies offering these services operate entirely online, they can run with lower overhead and provide the service more cheaply than traditional financial institutions. As a result, lenders often earn higher returns compared to savings and investment products offered by banks, while borrowers can borrow money at lower interest rates, even after the P2P lending company has taken a fee for providing the match-making platform and credit checking the borrower. – Wikipedia
What is RateSetter?
RateSetter started in the UK in 2009 and established a presence in Australia in August 2012.
Since launch RateSetter has grown to become the largest retail peer to peer lender in both the UK and Australia, funding over $2 million in loans per week in Australia alone.
RateSetter business model is as follows:
We match lenders who want a competitive return on their money with creditworthy borrowers who want a simple, convenient loan. We, amongst other things, operate the RateSetter Lending Platform, assess borrowers to ensure they are creditworthy, match lender and borrower orders, provide loan administration services, manage loan payments and manage claims on the Provision Fund to help protect lenders in the event of borrower late payment or default. – RateSetter PDS
Growth in the peer to peer lending market depends on positive outcomes for all stakeholders (i.e. borrowers getting a good deal and lenders getting repaid their loans plus interest).
From a standing start a few years ago the growth figures have been strong:
DIAGRAM: RateSetter Growth in Peer to Peer Loans since inception
Who Owns RateSetter?
RateSetter was brought to Australia in Australia in 2012, led by CEO Daniel Foggo, and officially launched to the public in November 2014.
Management and directors have skin in the game as they own the majority (51%) of the RateSetter Australia business.
In 2014 Carsales.com.au and Stratton finance became shareholders, a strategic move that enables an additional source of referred borrowers.
How Does RateSetter Work?
RateSetter is essentially a lending platform that facilitates the matching of loans between lender (members) and suitable borrowers.
EXTRACT: RateSetter PDS (version 5.00) – page 22
1.Who Can Be a Borrower?
RateSetter targets the personal loan market and their business depends on attracting creditworthy borrowers.
Loans may be secured or unsecured whether those loans be to individuals or businesses. Security may be taken over tangible or intangible property, for example, an automobile which is owned or proposed to be owned by a borrower.
RateSetter’s website provides an example of the types of borrowers they are looking for:
RateSetter advertises that using technology they can offer borrowers a better deal – usually in the form of a lower interest rate than alternative loan options.
EXTRACT: RateSetter Commercial – 1 May 2016
The interest rate disclosed by RateSetter for borrowers is as follows:
EXTRACT: Borrower Interest Rates on RateSetter as at 18 January 2017
2.Who Can Be a Lender (Member)?
RateSetter launched as the first P2P lender licensed to provide services to all Australians, not just wholesale and sophisticated investors.
Participation is available to all investors including individuals, self-managed superannuation funds, trusts and other entities. You must apply to be a member, and your membership application must be accepted by RateSetter Australia, before you can lend.
3.How Does RateSetter Make Money?
Ratsetter charges a 10% fee on gross interest for their service.
This approach is much the same as a real estate agent who manages a rental property on behalf of a landlord. It is the real estate agents job to manage the process and ensure the property has a good tenant, while the landlord will pay a percentage of rent for this service.
Just like a letting agent, RateSetter must keep both parties to the transaction happy in order to have a viable business.
It is in RateSetter’s interest to make sure that both borrowers and lenders have a good experience and most importantly that lenders don’t lose their money.
Lending on RateSetter
What does it mean to use the RateSetter platform as a lender (member)?
1.Who Sets the Interest Rate?
Interest rates are set by the market of lenders and borrowers, according to the supply and demand of funds at different interest rates.
EXTRACT: Last Matched Interest Rates on RateSetter – 7 February 2017
As you can see the rate is determined by supply and demand and will change over time:
EXTRACT: Historical Rate History as at 7 February 2017
Can I Choose Who to Lend To?
No. You don’t get to choose who to lend to, or whether security is taken for the loan.
You can only choose how much you wish to invest, in which lending markets, and at what rates.
You are relying on RateSetter’s experience and technology to manage the borrower risk.
EXTRACT: The Lender Screen (source: RateSetter PDS version 5.00, page 30)
3. When Do I See a Return?
The timing of payments will depend on the lending market in which you invest and other events such as borrowers repaying their loans early.
For each lending market, interest is ordinarily received on a monthly basis.
As a member you can see where all your loans are up to:
Can I Access My Money?
You can access cleared funds in your holding account at any time.
You cannot issue an instruction to withdraw funds that are on loan until those funds have been repaid (or alternatively as may be the case with the 1 Month and 1 Year lending markets, replaced by other investors) and cleared to your holding account.
Investors are only able to withdraw (or reinvest) funds at the end of the indicative term of the lending market in which they are invested, except where:
- The loan amount is repaid to investor through scheduled payment;
- Funds are repaid to investor by a borrower as a result of the borrower making an additional payment or repaying their loan early; or
- Defaults amounts are compensated by the Provision Fund (more on this soon).
The Risk of Lending Money
Lending money involves the risk that the borrower may not repay the loan and the interest owing.
No loan is 100% secure because no borrower is perfect and all lenders must plan for some level of default on their loan book.
Here you can see the current default levels of bank loans in Australia:
CHART: Australian Banks Non-Performing Loans
Lending institutions need to manage the risk of default by doing due diligence on borrowers and making sure they diversify their loan book.
It is also worthwhile looking to history to see how personal loans have fared particularly when the economy is no doing so well:
CHART: Historical Default Rates on Loans in Australia
It is also useful to see default rates during times of significant stress, such as the GFC in 2007-09.
CHART: Historical Default Rates on Consumer Loans in the US
The biggest spike in defaults in the US during the GFC came from residential mortgage loans (jumping from under 2% to over 11%)
What Does RateSetter Do to Manage the Risk of Defaults?
RateSetter was the first peer to peer lender to introduce the concept of a Provision Fund.
The Provision Fund is, as the name suggests, a pot of money as a means to help protect lenders from default by borrowers.
Who Funds the Provision Fund?
The money in the Provision Fund comes from charges paid by borrowers.
When a borrower applies for a loan they may be required to pay a Risk Assurance Charge, the amount of which is determined by a number of factors, such as their credit rating from independent credit reference agencies. The Risk Assurance Charge is paid into the Provision Fund, which is held in cash by a third-party trustee.
RateSetter determines when the Provision Fund will be used.
It is important to note that the Provision Fund is not an insurance product or guarantee, if borrower defaults are high enough you could still lose.
As you can see RateSetter has experienced defaults in Australia (currently an estimated $2,000,000 worth), however to date the Provision Fund has been sufficient to cover these defaults.
EXTRACT: RateSetter Provision Fund Statistics at 7 February 2017
RateSetter claims that it is the only consumer peer to peer lender globally to have delivered every investor every amount of principal and interest due (but remember RateSetter only started in 2009).
How Does RateSetter Manage Defaults?
RateSetter is transparent in the reporting of its credit performance:
EXTRACT: RateSetter Credit Performance Statistics at 7 February 2017
If there is a default, RateSetter will implement the following procedures:
Source: SQM Research Note – 20 July 2016
Who Has Been Borrowing on RateSetter?
The majority of borrowers have used funds for debt consolidation and home improvements:
Source: SQM Research Note – 20 July 2016
It is possible to view all the loans RateSetter has made since it started in Australia in 2014.
Talk about transparency, here it is:
The majority of borrowers thus far have come from NSW, QLD and VIC.
Source: SQM Research Note – 20 July 2016 (data snapshot at 30 April 2016)
- Peer to peer lending use technology to match borrowers and lenders
- RateSetter currently facilitates $2 million in loans per week in Australia
- Most borrowers have used RateSetter for debt consolidation or home improvements
- All lending involves risk of default, RateSetter uses a provision fund to help manage this risk
- If you want to be a lender member please ensure you read the PDS