The ins and outs of peer-to-peer investing

Financial planning Written by Squirrel Money, Feb 26 2018

The concept is quite a simple one. People with money to invest lend it to people who are looking to borrow. All facilitated through the online platform of a P2P provider. Think of it as a match-making service for money; one where looks don’t matter.    

The world’s first peer-to-peer lender, Zopa, was started in the UK in 2005 and has lent out over £1.99 billion in loans since its launch1. In New Zealand, P2P lending only became possible on 1 April 2014 after the Financial Markets Conduct Act 2013 was amended to enable peer-to-peer lending services to be licensed. As a result, the Financial Markets Authority issued its first peer-to-peer lending service license to Harmoney, who officially launched in October 2014, followed closely by Squirrel Money just over a year later, in November 2015. There are now several more players in this space in the New Zealand market.

Peer-to-peer lending has taken the world by a storm set to disrupt traditional financial markets, with large providers in most major countries like the USA, UK, Europe, Australia and NZ. 

How does P2P lending work?

Like Tinder, but for money. People looking to borrow money apply online through the P2P provider’s platform, and if approved for a loan, are matched up with funds from people who are looking to invest. The P2P lender simply provides the platform for the match to take place on.

In this way, P2P lenders cut out the middle-man and, because they’re run online, can keep overheads low. The benefit for borrowers is a loan with lower interest rates and fees and investors benefit through higher investment returns.

In New Zealand, investors are told they can expect to earn anywhere between 7% - 14% p.a. with borrowers enjoying ‘bank-beating’ interest rates2

It’s important to note that P2P lending still involves all the regulatory checks of a traditional personal loan, such as a credit check, ID verification and affordability calculations.

A diversified portfolio, factoring in demographic, credit profile and loan purpose for example, is key for any P2P lender as it allows for better credit control.

Types of P2P credit risk models

There are two types of models P2P lenders can adopt to manage credit risk for investors: a fractionalisation model or a reserve fund model.

The reserve fund model:

The reserve model approach has been popular in the UK market, with companies proudly reporting investors not having lost a single cent under this model to date. In New Zealand, this model has been adopted by Squirrel Money with the same claim.

The reserve fund model makes P2P investing a quick and easy process. Investors select the amount they wish to invest, the term and the minimum interest rate. These ‘investment orders’ are then matched with loans that meet these criteria. Investors receive regular principal and interest repayments on their investments, with the reserve fund available to step in and cover any missed borrower repayments. 

The reserve fund is funded by diverting part of the borrower’s interest at each repayment. In this way, the reserve fund model effectively socialises lending losses across the overall loan portfolio meaning individual investors do not bear the full credit risk of the individual loan or borrower to which they are matched.

The fractionalisation model:

The alternative peer-to-peer lending model that is most common is the fractionalisation model. This model has proved popular in the US market and is currently on offer in New Zealand through most peer-to-peer lenders.

The fractionalisation model manages credit risk by encouraging investors to spread their investments across multiple loans, thereby creating a diversified portfolio of peer-to-peer loans. Investors select the loans they wish to invest in and in the event of a missed repayment or borrower default, they directly suffer the loss. The fractionalisation model relies on successfully spreading credit risk across many different loans and achieving a net return, post credit losses, that is acceptable to the investor. Diversification needs to form a key part of the investment strategy under this model.

Best of the best – top P2P lenders

Here are some of the top P2P lenders in each major market:

RateSetter – UK

RateSetter3 is the brains behind introducing the concept of a reserve fund into P2P lending. Launched in October 2010, RateSetter has matched more than £2billion in peer-to-peer loans and has over 400,000 investors and borrowers.

Investors have three different investment plan options, with returns ranging from 3.1% - 5.1%. RateSetter has a reserve fund to help protect investors against credit losses.

Since 2010, RateSetter has won more than 20 top industry awards and was the highest-rated peer-to-peer lending platform by readers of Which? magazine in 2015 and 2016.

Lending Club – USA

Lending Club4 is the world's largest peer-to-peer lending platform, having lent out over $31 billion since it launched in 2007. It was the first peer-to-peer lender to offer loan trading on a secondary market.

Investors have historically been receiving returns of between 4% - 6%. Lending Club offers investors a mobile app to easily keep track of their investments.

RateSetter – Australia

RateSetter5 launched in Australia in November 2014, backed by the well-established and very successful Ratesetter group (which was established in the UK in 2010). Since then, RateSetter has matched over $230 million in peer-to-peer loans with nearly 10,000 everyday Australian investors.

Investors can expect to receive between 3.4% - 9.4% after fees. RateSetter Australia, also uses a reserve fund model to help protect investors against credit losses.

Ratesetter was the first P2P lender to release its loan book data in Australia, which they said demonstrated their commitment to developing real trust with borrowers and lenders.

Squirrel Money – New Zealand

Squirrel Money was the second cab of the rank as far as P2P lenders go in New Zealand, but offers a number of firsts for this market.

Investors are told to expect a net return between 7.89% - 8.88% per annum. Squirrel Money has a reserve fund to help protect investors against credit losses.

Squirrel Money is the first P2P lender in New Zealand to offer loan trading on a secondary market and offers investors a mobile app to quickly and easily manage their ongoing investments. Squirrel Money offers complete transparency to borrowers and investors with loan book data readily available.

A quick look at why you should invest in P2P lending

There are a number of things that sets peer-to-peer lending apart from other more traditional investment options.  

Getting started with a P2P investment is a simple process, completed easily online. To get started, investors set up an account with the P2P lender, then transfer some funds into their account. Once that’s all done they’re ready to start making investments.  

P2P investing offers investors a large degree of control over their investment. Investors choose how much to invest, what term the investment is over, and the desired rate of return. Under the fractionalisation model, investors also choose what degree of risk they’re willing to accept. That’s because under this model, the investor acts as his or her own credit manager and would have to bear the losses of any loans that default. This is a non issue under the reserve fund model, as the credit risk is borne by the P2P lender, with the reserve fund available to step in and cover any credit losses the investor might have suffered if a loan defaults.

One of the main drawcards for P2P investing is the comparably higher rates of return that can be earned when stacked up against a traditional savings account (albeit a much riskier option) but also when compared to traditional stock investments (after the higher risk of this class is factored in). Without having another investment class that is directly comparable to P2P investing, it falls somewhere in between these two. This type of investment may also offer less volatility than other investment options.  

It’s important to note that P2P investing does carry a risk. What that risk is varies across P2P lender and is heavily impacted by the credit risk model they’ve adopted i.e. reserve fund model or fractionalisation.

Lastly, P2P investing offers the more socially-conscious investor an outlet to invest more locally and directly in supporting people in their community. It can be seen as a more moral and positive investment.  

Useful terms and definitions to get you started

P2P = peer-to-peer

Net return = return after fees and taxes are deducted

Gross return = return before fees and taxes are deducted

Return = percentage of interest earned

Principal = the money originally invested

Credit risk = the risk of default from a borrower failing to make repayments

Fractionalisation = a credit model where the credit risk is borne by the investor

Reserve fund = funds set aside to cover credit losses

The future of P2P

With so many billions of dollars borrowed and invested, P2P lenders are a force to be reckoned with, but the sector is not without it’s challenges. Awareness. Education. Increased competition. Regulatory changes. Challenges come in many shapes and sizes.  

One thing that is clear, when looking at the size of the market and the introduction of so many new players, is that P2P lending is here to stay. It offers a somewhat unique alternative to traditional investment classes and with some great returns to boot.

Further adding to the strength of P2P lending, is the highly regulated space this investment class sits in. In the UK, lenders are regulated by the Financial Conduct Authority, in the USA they sit under the Securities and Exchange Commission. Looking a little closer to home, peer-to-peer lenders in New Zealand are regulated by the Financial Markets Authority (FMA).

Whichever way you look at it; P2P lending is an intriguing proposition.

This information is not intended to be financial advice and has been prepared without consideration of your particular financial situation or goals. Before making any decision about investing or borrowing you should seek independent financial advice.

If you are investing through Squirrel Money, check out this guide that has all the information you need to know about investing into the marketplace.



1 Peer-to-peer lending Wikipedia. Retrieved 13/2/2018

2 MoneyHub. Retrieved 13/2/2018

3 Ratesetter. Retrieved 13/2/2018

Lending Club. Retrieved 13/2/2018

5 Ratesetter Australia. Retrieved 13/2/2018


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