Zopa – money-lending without the banks
I read a recent post on PFIncome’s blog about Peer Lending, which reminded me of a British company called Zopa that I first heard about a year or two ago. Peer lending is also known as person-to-person (P2P), or social, lending. It is a mechanism by which people can lend and borrow money to and from other people, while cutting out the middle man – the banks.
During the current difficult times, with banks extremely unwilling to lend money, except perhaps on exhorbitant terms, the P2P lending model is particularly attractive, for borrowers and lenders alike. The borrowers get a loan at a fairer interest rate, and the lenders can charge more interest (and make a better return on investment) than they would get leaving their money in a savings account.
Of course, with lending money to people comes risk of default, and arguably it is exactly this risk becoming a reality that precipitated the global downturn. So who is Zopa, and how are the risks minimised?
Zopa started in 2005 in the UK – spawning branches in the US (briefly), Italy and Japan. The idea was somewhat emulated in the US by other companies such as Lending Club and Prosper. As this is an investment blog, let’s look at Zopa from the lender’s point of view.
What’s the deal with Zopa?
You join as a lender and add money to your account that you are willing to lend out to people. Zopa checks all loan applicants to determine their credit ratings, and groups them into the following categories: A*, A, B, C and Young Market (in increasing levels of risk to the lender).
The lender then puts an offer to the market. For example, an offer to lend £500 to A-rated borrowers for 36 months at 10% interest rate.
Then the borrowers can peruse all the offers on the market and decide to take one of them, or wait to see if any better offers crop up. If a borrower likes the offer, they sign a legal contract, which is dealt with by Zopa on the lender’s behalf, and then they pay back the loan over the 36 month period by Direct Debit.
And mitigation of risk, you might be wondering? If you lend £500 to borrowers in the A-rated category, Zopa actually spreads it out in £10 chunks across 50 individual borrowers. So there is less chance of losing your investment. If one of the borrowers misses a payment, a collections agency is employed using the same recovery process that the banks use.
And how exactly does Zopa benefit from this? They charge a one-off loan setup fee to the borrower (£118.50) and they charge the lender 1% of money currently out on loan. So as a lender you need to make sure your offered rate for lending out money reflects both this fee and takes into account potential loss of capital due to default.
The US versions of these P2P companies operate slightly differently and are also regulated differently. If you think peer lending is an ‘asset class’ you like the idea of as part of your portfolio, it’s probably best to stick to one that operates in your own country, as you’re more likely to understand that market. So in the UK, use Zopa; in the US use Prosper or Lending Club. And it is worth digging around for online forums for these companies to gauge opinion from others already involved.
Finally, like with stock market investing, make sure you understand the risks involved, and how to minimise them, and only use capital that you can afford to lose, if the worst happens, and borrowers do default.
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