What is Social Lending?

In a nutshell, social lending is the name given to a certain type of financial transaction which takes place directly between individuals or “peers” without the use of a traditional financial institution.

This type of person-to-person lending is also known as peer-to-peer lending (P2P lending), peer-to-peer investing and more commonly, social lending.

Social lending is a new way to borrow and lend money online with other people. As an example, when one person requests a loan through a social lending system, the people that are willing to lend that person money will all chip in to help loan that individual the amount they need. No banks are involved in the process, only people.

What are the benefits of Peer to Peer Lending?

As the social transactions don’t take place with the intercession of a banking institution there is potential to lower fees and interest rates for all parties involved. The social lending process also works as a convenient system for those with cash funds to invest directly in order to directly allocate their available capital to those individuals who may need it most, along with those users who they happen to know through the system.

This resulting social networking effect should in theory serve to help reduce the risks of borrower non-payment whilst at the same time enable the social lenders to gain some sense of social utility from having lent their money to someone they personally know.

It is worth noting that not all social lending transactions involve people who know each other directly, and the systems do allow for a network effect to come into play wherein a particular borrower can vouch for another user which helps to greatly increase the social lender pool.

Social Lending Sites – Finding the best Person to Person Lending website

With more and more new social lending websites popping up it can be tricky to find the best peer-to-peer lending community that’s right for you.

Even though these social lending sites don’t impose the same type of profit margins that the big banks do, they all do charge a fee to arrange the loan deals.

It is also worth keeping in mind that the websites are also currently unregulated, which means that if a borrower should default on their loan repayments then the lenders could stand to lose some or all of their money.

Whilst that may sound a little off-putting these social lending websites do use a variety of different methods to help control and lower the risks involved for lenders, so it is therefore important that you check carefully how the system works and operates before jumping in.

A key area to check is how they vet potential lenders in terms of their credit report and borrowing history.

It is also recommended that lenders spread their money across as many borrowers as possible in order to lower risk. Keep in mind that the higher the rate of interest you earn on money lent, the higher the risk.

Let’s take a look at a number of the leading peer to peer social lending websites currently operating in the UK.

Zopa

Zopa was the original social lending website to launch in the UK and over the years has seen strong growth in the peer-to-peer-lending market.

The Zopa system incorporates a number of strong risk controls, and screens all potential borrowers by checking their credit history along with looking at affordability factors too.

According to a Zopa spokesperson more than 75% of borrowers who apply for loans through the system are turned away, “Checking this can be time-consuming, but we think it is important to do. Many people may have a good credit score, but if they are taking on debt they would struggle to repay, we don’t want them.”

Zopa Loans invites lenders to choose the type of borrower that they wish to lend to, and let them decide how long they’d like the loan to be. In each of the categories there are a range of rates displayed where lenders can then set the return they’d like to earn on their money.

If the lender chooses to select an interest rate lower than the suggested system range, then their money will be snapped up almost instantly. Should they instead decide to go higher than the suggested range they may struggle somewhat to attract potential borrowers. The money loaned out through Zopa is lent in bundles of £10 which is distributed to borrowers in the given category who are looking to borrow at the lenders specified rate.

Zopa Details:

• Launched – March 2005
• Money lent to date – £110m
• Default rate – 0.7%
• Fee paid by lenders – 1% of the amount lent
• Fee paid by borrowers – Flat fee of £124.50 once loan is approved
• Borrower profile – Only lower-risk borrowers accepted, generally A* to C
• Average return for lenders – 8.1% over past year, after charges
• Spread of payments – No more than £10 with any one borrower
• Fund to cover bad debts – No

RateSetter

What sets RateSetter apart from other websites in the peer-to-peer lending space is the “provision fund” to help cover bad debts.

This fund is paid for by the borrowers themselves thanks to an additional rate charge. In the RateSetter system the lenders all receive the same fixed rate which is set by the market on the website on any given day.

For borrowers however, the interest rate that they pay is based on their credit risk. Borrowers deemed to be a higher risk will therefore pay a higher rate of interest on their loan. These additional payments are what are paid into the provision fund.

It is worth keeping in mind however that the provision fund isn’t guaranteed to cover all loan defaults in full. At present the fund covers six times the expect losses, but if defaults exceed this amount then the lenders will lose out.

Should the defaults be less, then any surplus money is credited back to the londers via means of a bonus.

Peter Behrens, a co-founder, said: “We think it is important to monitor the risk of borrowers on the site. Only about 10pc of applications get through at present. We think lenders want a market-beating rate, but don’t want to take on the additional risk of vetting individual borrowers.”

RateSetter also offer lenders the choice of a rolling month-to-month contract, which may be an attractive option for those who don’t want to have their money locked away for long periods of time, although as a result they will receive a lower return on their investments.

RateSetter Details:

• Launched – October 2010
• Money lent to date – £730,000
• Default rate to date – None so far, expected rate lower than 1.4%
• Fee paid by lenders – 10% of the interest they receive
• Fee paid by borrowers – £115 flat fee for a three-year loan; £5 monthly charge in the rolling market
• Profile of borrowers – Prime risk, primarily A and A*
• How checked – Credit reports from Equifax and CallCredit, plus manual assessment.
• Average return for lenders – 7% for three-year loans; 3.3% in monthly market
• Spread of payments – Money spread among all borrowers, regardless of their credit risk
• Fund to cover bad debts – Yes

Funding Circle

The main difference between Funding Circle and other social lenders is that with Funding Circle loans the money is loaned to small businesses, rather than individuals.

When signing up to the Funding Circle system all the companies are screened with a requirement that they have at least two years of audited accounts, although many will have far longer trading records.

Co-founder of the Funding Circle website, James Meekings, said that the site was aiming at low-risk businesses who are struggling to get finance from banks at affordable rates.

“Many of our borrowers are family businesses that have been running for 20-plus years.” Around 40% of the companies that are lent to are in the manufacturing sector.

In terms of interest rates on Funding Circle, the maximum amount of interest that can be earned is set at 15%, with the average rate closer to half this.

Lenders have the option to select an “autobid” tool that will allow them to set the rate they want, with money automatically distributed to the companies looking to borrow at this rate.

Funding Circle Details:

• Launch date – August 13 2010
• Money lent to date – £1.3m
• Default rate to date – None to date. Expected default rate of between 0.3 to 2.6%, depending on risk profile of business
• Fee paid by lenders – None currently, but next year a 1% annual fee will be introduced charged monthly from repayments
• Fee paid by borrowers – Upfront 2% fee of the amount borrowed
• Profile of borrowers – Low-risk businesses. No start-ups
• How are borrowers checked – Each business screened by in-house team
• Average return for lenders – 8.2%
• Spread of payments – Encouraged to diversify. Money spread among a minimum of 20 companies if using automated lending tool
• Fund to cover bad debts – No

Quakle

Similar to Yes-Secure, Quakle is a social lending website where borrowers can go into greater detail regarding what they’re seeking a loan for and the interest rate that they would like to pay.

Through the Quakle Loans system lenders are then encouraged to bid for the loans they’d like to contribute to, in most cases pledging a small part of the total amount asked for. The loan is only granted once it has been fully funded by Quakle lenders.

It appears that the only borrower information that is verified is their credit score provided by the relevant UK agency. Other personal information, such as the borrowers job status, whether or not they own their own home, or any debts they may currently have, might not be independently checked in the system.

As both Quakle and Yes-Secure are relatively new to the social lending scene, neither site has really established their own track record as such, with the average return being the APR rate paid by the borrower.

Should the borrower default on the loan, then obviously the return the lender will see will be far less. Despite robust credit checks it is interesting to note that on Yes-Secure for example, some A borrowers are often paying interest rates in excess of 20% which would suggest that lenders in the system aren’t really paying too much attention to user credit ratings.

When compared with other social lenders it seems that both Quakle and Yes-Secure seem to attract many borrowers at present who would find themselves rejected by other person-to-person lending websites, which would therefore suggest them to be a more high risk option for individuals lending money.

Quakle Details:

• Launch date – October 2010
• Money lent to date – £16,000
• Default rate to date – None. For A and B-rated borrowers it is anticipating a default rate below 1%,  for C and D-rated borrowers less than 3%
• Fee paid by lenders – None
• Fee paid by borrowers – 1.5% of loan once it’s agreed
• Profile of borrowers – Lower end – 70% of borrowers are C-rated
• How are borrowers checked – Grade dependent on credit reports from Equifax
• Average return for lenders -: 23.5%c
• Spread of payments – Low at present. Aims to create “autolending” function in future to increase diversification
• Fund to cover bad debts – No

Yes-Secure

• Launch date – June 2010
• Money lent to date – £150,000
• Default rate to date – None. Expected default rate of up to 12pc for higher-risk borrowers.
• Fee paid by lenders – 0.9%
• Fee paid by borrowers – £80 flat
• Profile of borrowers – From A* to E
• How are borrowers checked – Rating based on CallCredit report. Yes-Secure asks for a copy of their payslip and a recent bank statement
• Average return for lenders – Rates advertised from 15% to 30%.
• Spread of payments – Lenders contribute 5%c of the sum asked for which rises to 15% if you have made an “online connection” with the borrower
• Fund to cover bad debts – No, but plans to launch one soon