Frequently asked questions
The marketplace lending industry
+ What is marketplace lending?
Individuals and small businesses are no longer limited to applying to banks when they want credit. They can now apply online to marketplace lending platforms. The platform vets the application and, if approved, sets an interest rate and places it on the platform. Qualified investors who use the platform can choose to fund the loan at the agreed rate for a fixed time. The platform takes fees from the borrower and the investor.
+ Who are the borrowers?
On consumer platforms, borrowers are individuals looking for a loan for any number of reasons. The majority are taking advantage of better interest rates to consolidate existing debt, such as credit card debt.
On small business platforms, there are a broad range of potential borrowers, depending on the business type. The funds are typically used to fund expansion and growth. They are usually short-term in nature. The majority of small business platforms have minimum requirements for the borrower before they will consider originating a loan, such as minimum time in business. Many take personal guarantees from the owners of the business as well as security over business assets.
+ How do the online marketplace lending platforms get paid?
Platforms collect fees from borrowers and investors. Borrowers pay an upfront origination fee, ranging from ~1-5% of the loan size, and investors pay fees (usually 1%) for the platforms to service the loans.
+ Why invest in marketplace lending?
Accepted best practice globally is for up to half of an investment portfolio to be in credit and fixed income investments. Investing in our funds is a way to diversify your portfolio with an asset that is:
- Low volatility
- Offering high yields at lower risk
- Defensive because of its low correlation to other asset classes like shares and bonds
+ How big are the loans?
Loan sizes range from $1,000 to $500,000. The typical loan is in the region of $14,000.
+ Are the interests of marketplace lending platforms aligned with the interests of investors or those of borrowers?
Marketplace lending platforms have aligned themselves with investors in numerous ways. Platforms receive income from investors on a monthly basis as payment for servicing the loans. This 1% fee is charged based on the outstanding balance of the loan. If the borrower defaults on the loan, the platform does not get paid. The platforms also have an obvious incentive to originate high-quality loans that are likely to make all their repayments. If the platforms do not ensure quality control on their borrowers, investors will not purchase their loans. This will, in turn, lead to failure of the platform. Finally, the vast majority of platforms will reimburse any investor in the case of borrower identity fraud.
+ How accurate are the credit models of the marketplace lending platforms?
The credit models are based on current and past credit behaviour provided by a number of sources including the credit bureaus, application information from the applicant, and credit and payment data from third parties. Leading US consumer platforms believe their credit models are far more effective as generic credit bureau models. The software of marketplace lending platforms is built for online transactions. Their fraud prevention models are running at significantly better statistics than industry standards.
+ What is the quality of borrowers?
The average borrower on leading US consumer platforms are well into the prime category. The average FICO score is ~695 (anything > 660 is considered prime) while the average income is above US$70,000 which places them in the top 10% of all US earners. Typically, only 5-10% of applications get approved for a loan.
+ How different are these loans to those of the subprime crisis in 2008?
1. A focus on the ability to repay
The 2008 crisis originated from lending by financial institutions to un-creditworthy borrowers looking to benefit from the seemingly unstoppable rise in US housing prices. The lenders’ focus was on the asset not on the borrowers ability (or inability) to repay. The complete opposite is true for marketplace lending. Since the majority of these consumer loans are unsecured (i.e. there is no asset backing them), the entire decision on whether to lend money is based on the borrower's ability to repay.
2. Credit scores of the borrowers
The vast majority of borrowers on the major platforms’ standard programs have FICO scores of more than 660. We fund loans to borrowers whose FICO score is, on average, closer to 700. This ensures that the borrowers are prime borrowers, not sub-prime.
3. Different incentives to write loans
In the sub-prime mortgage crisis of 2008, intermediaries (such as mortgage brokers) had an incentive to write as many loans as possible because they received a commission for writing the loan. It didn’t matter to the intermediary if the borrower eventually defaulted — they already had their commission — so there was no incentive to assess the borrower correctly. The complete opposite is true in marketplace lending. Firstly, the platforms are paid to service the loans based on their outstanding balance. Secondly, if the platforms relax borrowing standards and have a large spike in default rates, investors will abandon that particular marketplace. Without investors to fund loans, the platform has put itself out of business.