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Peer-to-peer lending platforms allow investors to lend money directly to borrowers, cutting out the banks.
A bank’s primary purpose is to keep people’s savings safe, but this comes at a cost in the form of very low returns. In contrast, the purpose of peer-to-peer lenders is to help investors access healthy returns, which does not come with a promise of safety – instead, investors take on some risk.
Also unlike banks where the services offered are very similar across all banking brands, peer-to-peer lending platforms take different approaches to each other, for example in terms of how they work and who investors can lend to. Here, we look at one of the largest platforms, RateSetter, and ask what makes it different?
How does it work?
How are RateSetter’s interest rates set?
As the name RateSetter indicates, a feature of this platform is that it is the customers, rather than the platform, that sets the interest rate. When investing money, customers can either choose the Market Rate (which is the average of the interest rates from the previous day), or they can set their own interest rate (a low rate can mean your money is lent out quicker so your money starts earning sooner; a higher rate can mean it takes longer to match your money to a borrower but, once it is matched, you’ll earn a higher return).
So on this platform the interest rates can vary over time, and even within a day. The average interest rate for investors over the last few years is 4.4%.
How do you lend money with RateSetter?
RateSetter has always been regarded as one of the simpler ways to invest in peer-to-peer loans. There is no need for investors to trawl through lists of borrowers to assess and select the ones they like – the platform takes care of all that. All investors need to do is decide how much to invest and what level of access to their money they require. And the minimum investment is just £10.
The Provision Fund
One of the features that RateSetter is best known for is its Provision Fund. This is a central pot of money that helps investors manage risk. It is made up of payments from borrowers – the size of each borrower’s payment is related to their creditworthiness. If a borrower misses a payment, the Fund kicks in and makes the payment to the investor. As a result of this, to date, no individual RateSetter investor has lost a penny of capital or interest – although the platform makes clear that this isn’t a guarantee for the future.
Besides providing a buffer against missed loan payments, a key benefit of the Provision Fund is that it provides immediate diversification for investors. Some peer-to-peer platforms recommend that investors spread their investment across a number of borrowers to reduce the chance of lending to a borrower who does not repay. However, the Provision Fund spreads investors’ risk across all RateSetter’s active borrowers – close to 300,000 loans. This means that it is the performance of all the loans made though RateSetter that matters for investors, not just the loans they are matched to.
Who borrows?
Most peer-to-peer platforms specialise in one type of borrower – usually either unsecured loans to individuals or small businesses or secured loans to businesses. RateSetter diversifies across a wide range of types of borrowers, having built up specialist lending teams to deliver loans to creditworthy individuals, secured finance for businesses to buy assets, and secured loans for residential property developers.
This diversification of lending can be positive. Lending to only one type of borrower leads to what is known as “concentration risk”: it’s possible that that sector will be disproportionately affected by an economic downturn. RateSetter’s approach results in a portfolio which is well diversified across sectors and may be better positioned to withstand shocks.
In conclusion
Only you can decide whether RateSetter is the right peer-to-peer lending platform for you. If you are looking for a simple way to put your money to work in exchange for a degree of risk, it might be an option well worth considering.
