What happened to loans between individuals?
Even before Uber disrupted the taxi industry and Airbnb disrupted vacation rentals, the idea of peer-to-peer lending aimed to provide individuals with alternatives to traditional sources of consumer credit, both as borrowers and investors. But the fintech market is constantly changing. We’ll tell you what happened to the concept and how (and if) you can invest or borrow from a digital lender.
Most companies that started out as online platforms to connect consumers who wanted to borrow money with individual investors who funded loans, also known as peer-to-peer lending, now partner primarily with sources larger funding providers, such as banks and hedge funds, using their artificial intelligence tools to assess creditworthiness. Other players left the company or had regulatory issues. As the business model continues to develop, it is also referred to as market lending or fintech lending.
Nowadays, funding for digital loans by individual investors has been eclipsed in the market by larger sources of funds, according to Nimayi Dixit, fintech analyst for S&P Global Market Intelligence.
Yet the opportunities for individual investors to fund peer-to-peer lending remain, although as with any investment you will need to do your due diligence. Likewise, borrowers should shop around to determine where they can get the best deal, whether on a fintech platform or elsewhere.
How Fintech Loans Work
Dixit defined digital lenders in a report as “non-bank lenders who offer loans to consumers or businesses through digital channels. These lenders have unique funding models with liquidity provided by investors, credit facilities, securitizations or on-balance sheet liquidity.
According to the US Government Accountability Office, most fintech lenders now use a model in which loans come from bank partnerships that allow lenders to operate through bank charters rather than state lending licenses. This allows them to charge uniform interest rates nationwide and avoid state lending limits.
Then, fintech lenders buy these loans from banks and resell them to investors or keep them. A small number of fintech lenders issue loans directly and have lending licenses from multiple states. Dixit said few loans are truly peer-to-peer, meaning individual investors only make up a small portion of fintech loans.
To give an example, a leading fintech lender, Prosper, funds around 91% of its loans through what is called its “global lending channel”, or retail funding sources, while less than 10% of the funds come from what they call the “note chain”, noted Dixit. In 2020, the company could have had about $1.5 billion in loans, of which $1.4 billion was funded through the entire lending channel, he said. Peer-to-peer lending “is not a growing segment,” Dixit said, “at least not among the major players.”
Dixit noted that this is even true in the UK, where regulators have tried to foster peer-to-peer lending by treating it as a separate regulatory category and even creating a vehicle to encourage it as a retirement investment.
Digital lending is growing
According to S&P Global, “major fintech players have attracted massive capital and added new product lines and financial services features aimed at further entrenching customers to increase market share and improve profitability. Fintech companies in the United States attracted nearly $7.5 billion in venture capital funding in the second quarter of 2021 through 194 deals, up nearly 70% year-over-year. “The broader market is still strong, but it tends to be dominated by institutions rather than investors,” Dixit said.
The US Government Accountability Office attributes the growth of 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.
- They may cater to unserved market segments, such as people who need small business loans or people with limited credit histories who may not be able to get what they need online. through traditional banks.
- In some cases, they can provide loans at lower interest rates than banks for debt consolidation, credit card debt, and payday loans.
- Institutional investors are multiplying, expanding the funding available for lending.
- Less regulation can provide a competitive advantage as they don’t face the same capital or exam requirements. This also carries risks for the market and could change as some members of 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 loan and pandemic
The pandemic seemed to slow the growth of fintech loans, at least initially. “During the pandemic, this type of lending first declined when consumers stopped borrowing,” Laura Udis said. responsible for the small dollar market and the installment loan program at the Consumer Finance Protection Bureau. Udis pointed out that its information was based on third-party data, as the CFPB does not directly track this type of information. “I don’t think we have a good idea over the last two years of what the real impact will be.”
She noted, however, that it was “a very fast growing market through 2019”.
But the market rebounded in 2021 and reached higher levels than before the arrival of COVID, according to a report by Dixit for S&P Global Market: the environment, the increase in consumer demand and the decrease in Consumer stimulus measures have created a healthy demand for consumer credit. Retail-focused lenders have been able to operate in this favorable environment without facing some of the headwinds that (small and medium-sized business lending) and student-focused lenders have faced.
In 2021, the report notes, containment measures eased and government stimulus measures diminished as consumer spending increased. This has led to an increase in the demand for credit.
Some fintech lenders are having trouble
Lending Club, which pioneered the market in 2007, moved out of the peer-to-peer lending space, into more traditional financial services after acquiring Radius Bank last year. This followed a 2019 controversy in which the Lending Club paid $2 million in penalties to the Department of Justice and the Securities and Exchange Commission to resolve allegations that it misrepresented if borrowers met requirements. credit.
Then, in 2021, Lending Club was ordered by the Federal Trade Commission to return more than $10 million to more than 15,000 customers who were charged undisclosed fees. The company agreed to pay a total of $18 million to settle the FTC charges. Another digital lender, Avant, was ordered by the FTC in 2019 to return more than $2.7 million to customers who lost money due to “unfair and deceptive loan servicing practices.”
Is the loan between individuals a smart investment?
If you choose to invest in peer-to-peer loans, your rate of return will depend on several factors, including the credit rating of the borrowers you select for your investment. The main major player in the market is now Prosper. (Other players include Upstart, Avant and Marlette.) As for investors, “Prosper says no one who’s done more than 100 loans on their platform has ever lost money,” Rossman said.
The average return, Rossman added, is just over 5%. However, if you decide to invest in loans to people with riskier credit histories, you could see a return of over 14%. “It’s clearly not for everyone,” Rossman noted. But he said investing this way can appeal to the “altruistic” side of some people by providing a way to directly help other consumers.
“I wouldn’t advise putting more money than you can afford to lose in any of these peer-to-peer investments,” Rossman said. But it’s worth considering if you want to further diversify your investments and enjoy the rewards of helping individual borrowers, Rossman said.
Viktoria Krusenvald, CFO of Financer.com Ltd, was more bullish on P2P investing. It is, she says, “a great way for beginners to gain some 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 a financial mindset and maybe after gaining some P2P experience they are ready to dive into the stock market.
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 loans to shop and include digital lenders in their menu of selections. Be sure to consider loan origination fees when making your decision.
“Different shots for different people,” Rossman said. “On the borrower side, you probably won’t get the best interest rate, but who knows?