The consumer loans market is in the doldrums. Bank lenders have tightened credit criteria leading to lower credit availability as a result of the focus on responsible lending practices during the banking royal commission.
Another source of personal loans is a relatively new concept (in Australia) called peer-to-peer (P2P) lending. P2P lending has been in existence for at least 10 years in the US and Europe, gaining momentum after the global financial crisis when borrowers could not access finance other than through a credit card. Credit card rates remained at high levels, so P2P lending was another option that became available with more competitive interest rates relative to credit cards.
Different models of P2P lending exist but the traditional concept facilitates the matching of borrowers and lenders or investors over online platforms. The money used to fund loans comes from sophisticated investors, professional investors or the general public.
Borrowers – depending on their credit scores – may find personal loans at more competitive rates compared with what is on offer from bank lenders, as well as quicker turnaround times for a loan.
Not to be confused with short-term lenders that charge exorbitant interest rates, also known as payday lenders, P2P lenders can be a viable option for someone seeking a personal loan.
This is especially the case if funds are needed in a hurry or traditional sources of finance are not accessible. The popularity of balance transfer loans also supports the demand for P2P loans from those wanting to decrease credit card debt.
Lenders use credit scores when considering a loan application, but rather than one interest rate fits all, P2P lenders use risk-based pricing. Risk-based pricing means that there will be a range of interest rates offered by the lender and the applicable rate depends on the perceived credit risk of the borrower.
There is some concern that those in financial stress may seek a P2P loan due to being unsuccessful in getting a loan from other sources. Although not all borrowers will meet the lending criteria of P2P lenders, those that do and pay the higher interest rates may be putting themselves under further financial stress.
According to Financial Counselling Australia’s director of Policy and Campaigns, Lauren Levin, the way that risk-based pricing works is “essentially that the poor pay the most”.
A borrower needs to consider, “Am I getting myself into a debt trap? Could I save instead of borrowing and not pay all that interest?” Insurance works in the same way, because if you live in a poorer neighbourhood, your car and home insurance will be priced to reflect statistically higher property theft.
As is the case with any loan, potential borrowers need to see whether the loan is affordable – can the borrower meet the regular repayments and interest rate, as well as building in a savings buffer into the repayments?
Unexpected things happen in life – sickness, accidents, losing your job or a relationship breaking up – which may impact the ability to meet repayments.
As Ms Levin says “hardship assistance” must be made available by all lenders. Both banks and P2P lenders have the obligation to help those who are struggling to repay. There is also an ombudsman scheme, which is another avenue for any complaints about the lender.
(For help from a qualified financial counsellor, see the National Debt Helpline website.)
Finder.com.au lists five P2P lenders offering personal loans. Borrowers who decide to go down the path of a P2P loan should consider the following checklist:
- Application process: Online lenders do not usually have a ‘bricks and mortar’ operation, so there is an online application.
- Comparison rates: The comparison rate is an interest rate that also includes fees and charges to calculate the true cost of any loan, making it easier to evaluate personal loans from different lenders.
- Secured or Unsecured: Some loans may require security.
- Fixed or Variable interest rate: A fixed interest rate is usually applicable but some loans have variable interest rates.
- Term of the loan: Terms can vary from six months up to seven years depending on the lender.
- Interest rates: Interest rates can vary from as low as under seven per cent per annum to over 27 per cent per annum, depending on the lender’s judgement of the credit risk of the borrower (as sourced from Finder.com.au).
- Fees: Fees that may apply include establishment, ongoing, account-keeping, default or early exit fees.
- Repayment schedule: Often only monthly repayments are permitted, while financial institutions such as banks allow more frequent repayments.
- Loan purpose: Some lenders only approve loans for a particular purpose.