There’s a new way of borrowing and investing in town. Harmoney is the first New Zealand peer-to-peer lender to be licensed by the Financial Markets Authority. But more may be coming. We look at what you should know.
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Peer-to-peer lending, also known as P2P, is promoted as a borrower’s alternative to personal bank loans, payday lenders and credit cards. And for lenders (aka investors) it has potentially higher returns than traditional bank investments. But there are risks – particularly for investors.
The recent financial recession saw many banks in the UK and US pulling out of lending, and increasing their credit-card interest rates. At the same time, deposit rates hit rock-bottom. Consumers, fed up with banks, sought alternative sources of borrowing and investment.
Enter P2P lending, where borrowers and lenders are connected through an online middleman. Using an online platform meant the middleman could avoid the cost structures of traditional banks and offer better rates – to borrowers and investors.
P2P lending providers have mainly been aimed at individuals or small businesses looking for investment opportunities or loans. However, some established P2P platforms overseas are now accepting institutional investors – and even the banks are putting their money into them.
Back here the Financial Markets Conduct Act 2013 introduced new ways to raise money from the public and P2P lending was one.
Harmoney is the first New Zealand P2P lending provider to be licensed. It launched in September last year with $100 million to lend. This money has initially come from international and local investors. Heartland Bank has a 10 percent stake as well as providing funds for loans. And Trade Me has recently taken a 15 percent stake for $7.7 million.
The principle is simple. You borrow from a stranger at a lower rate than a bank would offer. Or you lend money to a stranger in return for a higher rate than what you’d get from a bank. It’s all done online. The aim is to help individuals or businesses to borrow at reasonable rates. “People investing in other people” is the term used by P2P lenders.
The P2P lending provider acts as a matchmaker, arranging the exchange through its website. It does the credit-checking, deals with the repayments and interest payments, and chases up defaults. It makes its money usually by charging fees to both the investor and borrower – and it may also take a cut of the repayments.
In the UK and US, some P2P providers match investors directly with potential eligible borrowers. For instance, a borrower might list their request for a car loan. Investors browse the website for loans in which to invest.
Harmoney lists individual loans that potential investors can browse and if the listing meets their criteria they may choose to invest in one or many listings.
Harmoney loans are split into $25 “notes” – a method they call “fractionalisation”. So you can choose which loans you want to invest in and how many of your “notes” to invest. Alternatively, Harmoney’s automated system will package together “notes” from loans that meet your criteria. For instance, you may only want to invest in loans with the least risk, or for certain purposes. Harmoney’s loans are graded from A1 to F5 based on risk.
For investors the rewards are higher interest rates than you’ll get from a bank.
In December, an A1-graded loan with Harmoney earned an investor a gross interest rate of 9.99 percent a year. An F5-graded loan had a rate of 39.99 percent. By comparison the best bank term-deposit rate available was 5.15 percent on a minimum investment of $20,000. Harmoney’s minimum investment is $500.
Harmoney has said its average net return to investors is about 12 percent. It takes a 1.25 percent cut on the principal and interest payments before the investor gets their monthly payment.*
By building a portfolio of loans that mature at different times an investor can also create a regular income stream.
The main risk for investors is they might lose their money. The loans are usually unsecured. Harmoney gives potential borrowers the option to include security – although currently it only accepts motor vehicles as security.
Loan defaults do happen. Zopa, a P2P lender in the UK, had a default rate of 0.39 percent on loans it made in 2013.
Harmoney has a forecast default rate based on the risk grade of the loan. The highest forecast default rate is 15.38 percent for an F5-graded loan. The lowest is 0.08 percent for an A1-graded loan. But it expects actual default rates to vary from its forecasts and is targeting an overall default rate of 4 percent. It’s said it will publish information about its actual default rates as this becomes available.
The borrower provides Harmoney with details of their identity, plus access to their bank and credit records. Harmoney assesses whether the borrower can pay back the loan. If Harmoney accepts the borrower’s application, the loan request receives a grade based on the risk of the borrower defaulting. Borrowers with a higher risk pay a higher rate of interest – and the investor also gets a higher rate.
P2P lending providers can refuse to accept a borrower. Harmoney says it’s looking for “bank grade” customers – those that a bank would accept.
Repayment defaults are handled by the P2P lending provider – the investor doesn’t have to play the heavy. Harmoney says its borrowers will receive a reminder in the lead-up to their repayment dates and will be contacted if the payment isn’t made. Late payments incur an overdue fee ($30 per month, $75 after 60 days) that goes to Harmoney, as do any dishonour fees ($15). If a loan defaults, Harmoney sends it to a debt collection agency. In cases where Harmoney takes legal action, it’ll take its costs out of what it recovers before the balance is paid to investors.
Overseas some P2P lending providers have funds held in trust to cover defaults, so investors don’t lose out. They fund this through the fees the borrower pays.
Harmoney’s “fractionalisation” method also spreads the risk. If one of your borrowers defaults you have less to lose because your investment is spread over several loans.
However, P2P lending providers aren’t banks and they don’t have the prudential regulation that applies to banks. They’re not the financier; they’re an introduction service. Invest with a bank and your money isn’t at risk when someone doesn’t pay back their personal loan – the risk is the bank’s. Invest through a P2P lender and that risk is yours.
The P2P lending providers aren’t free from failure either. Quakle in the UK went under in 2011, leaving investors high and dry. And China has seen a number of P2P lending websites close as borrowers defaulted.
A potential drawback for investors is that you can’t always withdraw your funds early. You could be tied in to the length of the loan - or you could be charged a fee if you withdraw early. Harmoney says you can withdraw the money in your investor account at any time but funds on loan can’t be withdrawn. When your money is in the investor account you aren’t earning interest.
For borrowers, the rewards are potential access to unsecured lending you mightn’t get elsewhere at a better rate. In December, the best interest rate for an A1-graded loan at Harmoney was 9.99 percent. In comparison a low-interest American Express card was charging 12.69 percent and an unsecured personal bank loan ranged from 13.95 percent to 19.2 percent.
Harmoney’s minimum loan amount is $1000 and the maximum is $35,000. Terms are three or five years. Harmoney charges borrowers an upfront fee of 2 to 6 percent of the loan amount depending on their risk grade (the minimum fee is $300).** This gets added to the loan and it’s paid to Harmoney when the loan’s issued. There’s no penalty for early repayment.
Borrow $10,300 (including a $300 fee) from Harmoney at 11.99 percent over three years and you’ll pay back $12,314. In comparison, borrow $10,250 (including a $250 establishment fee) from a bank at 13.95 percent and you’ll pay back $12,603.
It’s all done online. The only people making a judgement on whether they’ll lend you the money are the potential investors. They have demographic information about you – such as your residential and employment status – and a summary of your credit history. But there’s nothing that’ll identify you.
The loan contract is between the borrower and the investors. The investors are represented by a trustee arrangement for each loan.
The main risk for a borrower is not finding a match. Once Harmoney’s approved your application, it’s listed for 14 days and if it’s not fully funded after this time it’ll be removed. You’ll then be contacted and given the option to withdraw it or relist with a different amount.
The Financial Markets Authority (FMA) has standards for licensing P2P lending providers. There are also ongoing requirements.
Directors and senior managers must be fit and proper for their position and the business must be capable of performing effectively and in keeping with its obligations. It must meet all the requirements and obligations of the Financial Markets Conduct Act, including providing disclosure statements and easily understood client agreements. Another requirement is membership of a financial dispute resolution scheme and professional indemnity insurance.
The provider must also ensure borrowers don’t exceed borrowing limits. The regulations for providers limit the amount an individual or business can borrow from New Zealand P2P lending providers to $2 million in a 12-month period. But P2P providers may limit borrowers to smaller loans than this.
Harmoney is also required to have a contingency plan to protect an investor’s money if it goes under. If Harmoney fails or its licence is revoked, existing loans will continue to be managed, investors’ payments collected, and defaults followed up by a “back-up servicer”. When they’re not out on loan, investors’ funds are held in an investor trust account at ASB, not by Harmoney.
The FMA has more information on peer-to-peer lending.
by Kate Sluka
∗ From 13 June 2016 Harmoney will replace the 1.25 percent Service Fee with a tiered fee charged on the interest only. It will be based on how much principal each lender has invested.
** In December 2015 Harmoney changed the Borrower Fee to a flat Platform Fee of $375.
If you want to borrow money, it’s standard for a potential lender to ask for evidence of your income and expenses – usually bank statements. It needs to see you have the means to make repayments. However, it’s not standard for banks to ask you to hand over power of attorney to give them access to your statements.
But that’s what you’re doing if applying for a loan with peer-to-peer lender Harmoney and using Credit Sense – a company that provides a bank statement retrieval service. While applicants can send in bank statements themselves, Credit Sense is recommended by Harmoney “to process your application as quickly as possible”.
To use Credit Sense, you have to enter your internet banking username and password on Harmoney’s website and tick a box agreeing to Credit Sense’s terms and conditions.
By ticking the box, you’re appointing Credit Sense as “your true and lawful attorney-in-fact and agent”, with the power to log-in to your bank account and download your statements. But the 1700-word terms and conditions also require you to agree use of Credit Sense’s service “is at your sole risk”.
The company also disclaims “all warranties of any kind”, including that its service is fit for purpose and secure. It claims it won’t be liable for any damage resulting from the use of the service, including damage arising from unauthorised access to your data.
Credit Sense’s Mike Park, head of product management, says the service is safe but “it is impossible to absolutely guarantee internet security”. Mr Park defended the company’s terms and conditions, stating it hasn’t had any complaints and other businesses use similar clauses.
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