Peer-to-peer lending: online matchmaker for your funds

"Neither a borrower nor a lender be," Polonius memorably urged his son in Hamlet , but if you're looking to make decent returns in a low-interest-rate environment, you might want to discount such advice.

If you fancy you can do a better job of lending money than the ill-fated Anglo Irish Bank, you might want to consider peer-to-peer lending, where you lend your hard-earned savings instead of putting them on deposit, with the promise of returns of as much as 15 per cent on your money.

Non-bank lending is growing in popularity all over the world – in the UK it increased by more than 800 per cent between 2011 and 2013. Closer to home, it has been estimated that the Irish market could be worth about €100 million within three years. But is it as good as it sounds and what risks do you have to consider?

How does it work?
You could think of it a bit like an online matchmaking service. Instead of looking for a partner, you're looking for a good match for your funds – a business which will repay the loan on time and pay you a handsome reward in return.

Online intermediaries facilitate the matchmaking element of the transaction, allowing you to allocate your funds to a borrower who needs the money to fund some element of their business.

The online platform also handles the unsavoury side of lending, such as collecting monthly repayments, and you can expect the first repayment from a borrower to arrive within a month of your lending to them. In return, the online platform will take a fee on all the lending you do.

LinkedFinance is currently the only operator in the Irish market. It takes a fee of 1.2 per cent of the amount you lend out through its website. So, if you lend €10,000 over a year, it will take €120.

Our Money is another platform due to launch in Ireland in May. According to preliminary information on its website, it allows you one loan for free, and thereafter charges a €4.99 monthly subscription, or €60 a year. With Our Money you can lend as little as €20, while with LinkedFinance you can make a bid on a loan from between €50 to €2,000.

Borrowers are also charged a fee to use the service – 2.5 per cent of the amount raised in the case of LinkedFinance.

How much can I make?
That depends. LinkedFinance promises an interest rate of between 5 and 15 per cent, with chief executive Peter O'Mahony noting that the average rate to borrow funds on the website so far is 8.9 per cent.

The website operates an auction, where you can automatically bid on a loan that meets your criteria. If, for example, ABC Ltd is looking to borrow €10,000, you can make a €150 bid at an interest rate of, say, 12 per cent.

If ABC can borrow this money from other lenders at a lower rate, you won’t get in on the loan, or to do so you will have to offer a lower rate. If they can’t raise the money elsewhere at better terms, however, you could stand to earn such a return. Remember that just like any other investment, you will have to pay tax on any money you make. According to the Revenue Commissioners, income from such lending will be charged at your marginal rate of tax.

Entrepreneur Sean O'Sullivan of Dragons' Den fame has made a recommendation through a report from the Irish Entrepreneurship Forum to offer lenders some form of tax relief. Similar to the rent-a-room scheme, which allows people to earn €10,000 tax-free from renting a room in their home, O'Sullivan has suggested that crowdfunders should earn a similar amount of interest tax-free.

What are the risks?
Bad debts, arrears, impaired loans. Over the past number of years, we have all come to learn the language of lending, and as the State's banks and the taxpayer have learned so harshly, lending carries substantial risk. If your borrower fails to repay your loan, you could stand to lose all your money. And there is no Investor Compensation Scheme to help bail you out when you engage in lending.

In the UK, the default rate has typically been of the order of 1 per cent, with one of the larger players, Funding Circle, reporting a default rate of 1.4 per cent on the £262 million (€318 million) it has lent since 2010.

According to O’Mahony, since launching last summer LinkedFinance has lent about €2.4 million through the site to 82 businesses, and has more than 5,500 registered lenders. So far, it has had “zero defaults” and “zero late payments”.

O’Mahony argues that defaults tend to be lower in peer-to-peer lending because of the “community effect”. “If a borrower borrows off 200 people, including friends, customers, family, and people in their community, they tend to be far more responsible for paying it back.”

To mitigate any risks, his advice is to spread the risk by allocating your funds to 20 or so loans. The average loan through the site is about €30,000 over a three-year term, with a typical lender lending about €150 at a time, so each loan will have about 180-200 separate lenders.

If you choose LinkedFinance’s Autobid option, your money will automatically be allocated to different borrowers. “It spreads the risk if lenders are getting involved in multiple loans in case one of the businesses defaults in the future,” says O’Mahony.

But before you think it's going to be 12 per cent return for zero risk, remember that the history of peer-to-peer lending, both in Ireland and further afield, is still very young. And, as the Financial Times has warned, when intermediaries have no "skin in the game", as is the case with peer-to-peer lending, they have no explicit interest in making sure the loan is a decent one.

Another consideration is the structure of the loan. Does it, for example, include a lump-sum payment at the end, which might increase the risks of you not getting back your money?

Borrowers with LinkedFinance repay a fully amortised loan, which includes principle and interest each month, with no lump-sum due at the end.

With regard to late payments, O’Mahony says LinkedFinance handles such matters within its office for the first 30 days. Beyond that, it employs a third-party debt recovery firm to pursue the borrower on the lender’s behalf. The costs of this are borne by the borrower.

Is it regulated?
Peer-to-peer lending is not currently regulated by the Central Bank in Ireland. However, a spokeswoman says that it is "actively considering whether this type of platform should be regulated". For O'Mahony, "the main benefit of being regulated would be to give people an extra layer of confidence".

The UK has already started to move on the sector, and since April 1st, peer-to-peer lenders are being policed by the Financial Conduct Authority (FCA), which will mean more rights and greater protection for those who use them.

The FCA’s oversight will include imposing minimum capital requirements, rules to protect “client money”, and a requirement that steps are taken to make sure repayments on existing loans would continue to be collected if a site went bust.

UK operators also offer some protection for lenders on potential losses. Zopa for example, one of the largest operators in the space, puts some of the fee borrowers pay into a “safeguard” fund. This is maintained to cover savers for any loss of capital or interest when a borrower is unable to repay and goes into default. However, it typically offers lower returns of about 5 per cent.

Another important factor to consider is where your money is kept. LinkedFinance for example keeps client funds in a totally segregated lenders’ funds account at RaboDirect and has employed PricewaterhouseCoopers (PwC) as its auditor.

If the funds are appropriately segregated, even in the event that the platform itself goes out of business, it should mean that lenders won’t lose their funds, and a third party will step in to ensure that loan repayments are maintained.

Who am I
lending to?
Speaking at a recent Oireachtas committee hearing, Bank of Ireland chief executive Richie Boucher said: "lending is all about the ability to predict future cash flow". But it may be difficult to assess this when you're not considering the loan applications yourself.

According to O’Mahony, LinkedFinance carries out a detailed due diligence on every potential borrower, including the same credit checks that a bank would do, a consideration of their past performance, a tax clearance statement and an in-depth analysis of their bank statements for six months, as well as full identity and money laundering checks.

Rather than assigning a risk to companies, LinkedFinance categorises them as: C - consumer; M - manufacturing, industrial and agricultural; Y - young businesses; and K - knowledge, information technology (IT) and expertise.

But is it the case that companies who avail of peer-to-peer lending are those who are deemed to be not good enough for a bank to lend to – and who therefore may be a greater credit risk? O’Mahony doesn’t think so.

“It’s not that they can’t; it’s that they choose not to. Maybe they can’t wait 10 weeks for a bank to process the paperwork, or in some cases they are being offered credit on unreasonable terms,” he says, adding that an interest rate of 8.9 per cent can also compare favourably with a rate of in excess of 10 per cent that a bank might offer for unsecured lending.

The platform looks for "very solid businesses with a great track record", and won't lend to start-ups but looks for companies that are at least two years old. O'Mahony says the company rejects just over 45 per cent of people who apply.


Case study: A business you could be lending to
Paul O'Callaghan of Evofitness successfully got bank funding of about €25,000 to launch his first gym in Dublin back in 2011. So far so good, but the bank then said: "Don't come back to us for three years."

Unfortunately this didn't tally with his "aggressive expansion" plans, and when an opportunity came up to launch another gym at Avoca on the N7, O'Callaghan was stuck for finance.

His own bank lived up to their word and refused to advance any further funds, and he was waiting up to six weeks for a response from other banks. So, when he heard about peer-to-peer lending, he jumped at the chance.

“We didn’t tick all the boxes straight away, but they worked with us,” he says of his experiences with LinkedFinance.

O’Callaghan was originally looking to raise €25,000, but LinkedFinance suggested €20,000 as a more appropriate target. And within just eight days, he had his money, borrowed at a rate of about 10 per cent from 80-plus borrowers, including friends, family and customers of the gym. He has used the site again to raise a further €10,000 at about 9 per cent.

While most of the lenders may be unknown to O’Callaghan, he has recognised more than a few from their log-in names on the website, and it’s this personal element that brings with it added pressure to keep up repayments on the loan.

“I’d miss my own wages to make sure that [repayment] goes through. It’s not just a faceless institution; it’s people who are training with you, who identify with your brand.”

The only downside of this way of borrowing is the term of the loan, says O’Callaghan, with repayments spread out over three years, rather than five or six years, which could offer more breathing space.