Even before Uber disrupted the taxi business and Airbnb disrupted vacation rentals, the idea of ââpeer-to-peer lending was intended to offer individuals alternatives to traditional sources of consumer credit, both as borrowers and investors. But the fintech market is constantly evolving. We’ll fill you in on what became of the concept and how (and if) you can invest or borrow from a digital lender.
Most companies that started out as online platforms to match consumers looking to borrow money with individual investors who funded loans, also known as peer-to-peer lending, now primarily work with larger funding sources such as banks and hedge funds their artificial intelligence tools for assessing creditworthiness. Other players have gone out of business or faced regulatory issues. As the business model continues to grow, it is also referred to as Marketplace Lending or Fintech Lending.
According to Nimayi Dixit, fintech analyst for S&P Global Market Intelligence, digital loan funding by individual investors is being dwarfed by larger funding sources in the market today.
Still, opportunities remain for individual investors to fund peer-to-peer lending, although as with any investment, you need to do your due diligence. Likewise, borrowers should look around to see where they can get the best terms, whether on a fintech platform or elsewhere.
How fintech loans work
In a report, Dixit defined digital lenders as ânon-bank lenders that offer credit through digital channels to consumers or businesses. These lenders have unique funding models with liquidity provided by investors, credit facilities, securitizations or on-balance sheet cash.â
According to the US Government Accounting Office, most fintech lenders are now using a model where loans originate through banking partnerships, allowing lenders to operate through bank charters rather than government lending licenses. This allows them to demand uniform interest rates nationwide and bypass state credit limits.
Then the fintech lenders buy these loans from the banks and sell them to investors or keep them. A small number of fintech lenders lend directly and hold multi-state lending licenses. Dixit said not many loans are truly peer-to-peer anymore, meaning individual investors make up a small portion of fintech lending.
To cite an example, a prominent fintech lender, Thrive, funds about 91% of its loans through its “whole loan channel,” or retail funding sources, while less than 10% of the funds come from its “notes channel,” Dixit noted. In 2020, the company may have had about $1.5 billion in debt, of which $1.4 billion was funded through the full credit channel, he said. Peer-to-peer lending “is not a growing segment,” Dixit said, “at least not among the big players.”
Dixit found this to be true even in the UK, where regulators have attempted to encourage peer-to-peer lending, treating it as a separate regulatory category and even creating a vehicle to encourage it as a retirement investment.
Digital lending is growing
Accordingly S&P Global, âMajor fintech players have attracted massive capital and added new financial services product lines and capabilities aimed at further entrenching customers to gain market share and improve profitability. Fintech companies in the US attracted nearly $7.5 billion in venture capital funding across 194 deals in the second quarter of 2021, a nearly 70% year-over-year increase. “The broader market is still strong, but it’s dominated by institutions rather than investors,” Dixit said.
the US Government Accounting Office attributes the growth in the fintech lending industry to several factors:
- Technical innovations such as the use of new data sources allow them to improve response times, speed up loan approvals and facilitate financing.
- You can serve unserved market segments, e.g. B. People who need smaller loans for businesses or people with limited credit histories who may not be able to get what they need through traditional banks.
- In some cases, they can offer loans at lower interest rates than banks for debt consolidation, credit card debt, and payday loans.
- Institutional investors are increasing and expanding the financing options for loans.
- Less regulation can provide a competitive advantage as they don’t face the same capital or audit requirements. This also poses risks to the market and may change as some in Congress have moved towards increased regulatory scrutiny of the industry.
Ted Rossman, Senior Industry Analyst at Bankrate.com, described market lending as a “niche market” that has stabilized after a somewhat bumpy start.
Digital lending and the pandemic
The pandemic appeared to slow fintech lending growth, at least initially. “During the pandemic, this type of lending initially declined as consumers stopped borrowing,” said Laura Udis. Small dollar marketplace and installment loan program manager at the Consumer Finance Protection Bureau. Udis stressed that their information relied on third party data as CFPB does not directly track this type of information. “I don’t think we’ve had a good idea over the past two years of what the real impact is going to be.”
However, she noted that this “was a really fast growing market up until 2019.”
But the market rebounded in 2021, reaching higher levels than before the outbreak of COVID, according to a report prepared by Dixit for S&P Global Market: âPeople-centric digital lenders are estimated to have 37% more loans in 2021 compared to 2019 forgive. A healthy consumer credit environment, rising consumer demand and declining consumption stimulus ensured healthy demand for consumer credit. Personally-focused lenders have been able to thrive in this benign environment without facing the headwinds (small and medium-sized business lending) and student-focused lenders have faced.â
In 2021, the report said, lockdowns eased and government stimulus eased as consumer spending surged. This led to an increase in credit demand.
Some fintech lenders are in trouble
Lending Club, which pioneered the market in 2007, is out of peer-to-peer lending and moving into more traditional financial services acquired Radius Bank last year. This was followed by a controversy in 2019 in which Lending Club paid $2 million fine to the Justice Department and the Securities and Exchange Commission to resolve allegations that misrepresented whether borrowers met loan requirements.
Then, in 2021, Lending Club was appointed by the Federal Trade Commission Returned more than $10 million to more than 15,000 customers who were charged undisclosed fees. The company agreed to pay in full 18 million dollars to pay the FTC’s fees. Another digital lender, Avant, was ordered by the FTC in 2019 to repay more than $2.7 million to customers who lost money due to “unfair and deceptive credit management practices.”
Is Peer to Peer Lending a Smart Investment?
If you choose to invest money in peer-to-peer lending, your return will depend on several factors, including the creditworthiness of the borrowers you choose to invest in. The primary key player in the market is now Thrive. (Other players are e.g upstart, avant and Marlette.) Regarding investors: “Prosper says that nobody who has made more than 100 loans on his platform has ever lost money,” Rossman said.
The average yield, Rossman added, is just over 5%. However, if you choose to invest in loans to those with riskier credit ratings, you can earn a return of more than 14%. “It’s clearly not for everyone,” Rossman noted. But he said investing in this way could appeal to some people’s “altruistic” side by providing a way to help other consumers directly.
“I wouldn’t advise putting more money into any of these peer-to-peer investments than you can afford to lose,” Rossman said. But it’s worth considering if you want to further diversify your investments and appreciate the reward of helping individual borrowers, Rossman said.
Viktoria Krusenvald, finance manager at Financer.com Ltd, was more optimistic about P2P investing. She said it was âa great way for beginners to gain investment experience and start thinking about their money analytically. It’s far less daunting than investing in stocks, and most P2P platforms offer low minimum investment thresholds, giving everyone a chance to think about their money and their future. P2P can be something of a starting point that helps people develop an attitude towards money and maybe after gaining P2P experience they are ready to dive into the stock market.â
Should you borrow from a digital lender?
Rossman said digital and peer-to-peer loans are “definitely worth considering” as a borrower. But he said, “You probably won’t get the lowest interest rate.” He encouraged consumers looking for credit to shop around and add digital lenders to their menu of choices. Be sure to consider the lending fees when making your decision.
“Different shots for different people,” Rossman said. “You probably won’t get the best interest rate on the borrower side, but who knows?”