Impact of Rising Interest Rates on Peer-to-Peer Lending
P2P lending or peer-to-peer lending is a very popular form of loan especially for those who have a low credit score. Lenders provide loans to applicants through an online platform in P2P lending. P2P platform is beneficial for retail investors as they use this platform for investment. The P2P platform enables retailers to directly lend the money to borrowers and thus getting higher returns than traditional investment instruments and borrowers getting loans at competitive interest rates.
As per the current scenario, the fluctuating interest rates of the market will not directly influence the P2P lending rate. But as per the report of Lending Club, one of the leading P2P platforms in the US, the fluctuation in interest rates may discourage the investors and borrowers to participate in the marketplace which may eventually affect their business. The industry is, however, growing at a rate of 100% for the past few years.
The P2P lending interest rates vary from 5% - 35% in some cases. The default rate varies from 1.5% - 10%.
What does the rising interest rate mean?
The investors make money from the interest paid on the loans in proportion to the amount invested. If the interest rate rises then investors get more return. When it comes to P2P platform, the borrowers are assigned a credit risk rating based on their scores. If the credit rating is low, the borrower is assigned higher rates. For example, at Lending Club, G grade loans have an interest rate of 25.72%. If the borrower doesn’t default the payment, then the investments become more lucrative as compared to low-risk loans.
What are the downsides of a rate increase on the P2P platform?
As mentioned above, the high-interest rates fetch more return to the investors, the lower rates may affect them adversely. If the P2P lending platform offers a higher interest rate, then the borrower might drift away and start searching for other options. This will leave a small pool for the investors to invest in and thus affecting their returns.
To compensate this, the investors might issue lower-quality loans and may give the loan to risky borrowers which are again a problematic situation for the investors. If the borrower doesn’t find the platform they are using offers the kind loan products they are looking for, they might drift away their assets to somewhere else.
Another problem that may arise is that the borrower might just turn as defaulters. Since the higher interest may lead to more loan payments in the form of EMI, the heavy burden of repayment may turn them as defaulters.
The crux of the matter is that the P2P platform is a great investment and lending platform. It’s a good way to get the personal loan approved especially for those who have a low credit score. P2P platforms have other benefits like there is no prepayment penalty, easy approval, no hidden cost, and more flexible offerings. As and when the investors and borrowers will find the P2P platform more lucrative and beneficial, the banks will have to improve their system to become more efficient. But as interesting it may sound, the lenders and the borrowers must take other factors like interest rate into account before investing or lending from a P2P platform.