A new wave of online marketplaces is offering savers, investors and those running their own super funds much higher interest rates on their cash than they can get from banks.
Peer-to-peer (P2P) lenders are offering at least 5 per cent for a term of a year, and much higher returns than that for longer periods. That's significantly more than the 3 per cent that can be earned on a bank term deposit.
Although the amount lent to P2P lenders is small beer, it's early days.
They could challenge the dominance of the banks, at least in some product categories.
All use "risk-based pricing", where borrowers with the best credit scores pay lower rates of interest than those with poorer creditworthiness.
With a bank, everyone who wants a car loan who is considered a good risk pays the same interest rate.
With P2P lenders, the investors say how much money they want to invest, the term and the interest rate they want to receive. Then it is an auction process to match-up lenders with borrowers.
Borrowers like them too as they pay lower rates of interest than they would with the banks.
P2P lenders, with their low costs, are exploiting the fat margins enjoyed by the big banks that dominate the market.
However, investing through a P2P lender involves risks.
For one thing, a term deposit or any deposit with a regulated entity such as a bank or a credit union comes with a government guarantee on the first $250,000.
Some of the P2P lenders have very small minimum investment levels. RateSetter, for example, requires a minimum investment of only $10.
Lenders bid mostly on unsecured and secured consumer loans, such as car loans and on debt consolidation loans and don't know anything about the borrowers.
RateSetter says it checks the credit worthiness and the ability of the borrower to re-pay the loan. It has a "Provision Fund", through which lenders can be "compensated in the event of a borrower late payment or default"; though, it is "not a guarantee nor an insurance product and your capital is at risk".
TruePillars, with a minimum investment of $50, provides lenders with a credit worthiness assessment of the borrower that is sourced from a credit rating agency. Its borrowers are mostly very small businesses, such as sole traders and partnerships, and the loans are mostly unsecured.
As with RateSetter, lenders don't know the identity of the borrower; though, they do receive financial information about the business borrower as well as the credit rating.
While P2P lenders could be a good option as part of a well-diversified portfolio, they are not like having your money with a bank.
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