When we talk about borrowing money, the first name that clicks as a lender is a bank or a NBFC. There can be multiple types of loans. You can go for a home loan, personal loan, gold loan, loan against property etc. However, in all these cases, the lender is a bank or a financial institution. If I were to tell you that you can borrow from individuals too, your mind will go back to local money lenders who charge usurious interest rates. No, that’s not who I am talking about. I am talking about regular individuals like you and me for whom lending is just a way to earn higher interest rate.
How Do You Find Such Lenders?
That is a problem. Where do you find such people? You can’t simply keep asking random individuals if they will be willing to lend to you. Can you? Fortunately, for you, there are many websites (Peer to Peer lending platforms) that bring together such borrowers and lenders. You can think of these P2P lending platforms as marketplaces. The prominent ones I could figure from Google search are FairCent, LenDenClub.com, i2ifunding and LendBox.
As a borrower, you can put up your requirement and the rates you would like to borrow at. As a lender, you can review various proposals and decide where you want to invest (lend). P2P lending platforms will facilitate documentation and exchange of funds between the borrower and the lender. You can check out these websites for exact process details.
What Is the Regulatory View of These Platforms?
The good part is the Reserve Bank of India has come out with the master directions (guidelines) on Peer-to-Peer lending. This will give the entire framework much needed credibility. You can go through RBI master directions on Peer to Peer lending platforms dated October 4, 2017 here.
Here are some of the key points of RBI directions.
- The P2P lending platform must register as a Non-Banking Financial Company.
- The aggregate exposure of a Lender to all the Borrowers across P2P platforms shall not exceed Rs 10 lacs at any point of time. (No matter how attractive the rates are, you can’t lend beyond a point).
- The aggregate loans taken by a Borrower from all the Lenders across P2P platforms shall not exceed Rs 10 lacs at any point of time. (So, don’t pin hopes on borrowing a very big amount from these platforms)
- The exposure of a single lender to a borrower across all the P2P platforms shall not exceed Rs 50,000. (Good, as a lender, this stops you from putting too much money with the same borrower).
- P2P platform must obtain a certificate from the borrower/lender that the above limits are being adhered to.
- The maximum duration of the loan can be 36 months. In my opinion, a high rate of interest and the short loan duration is a problem for both the borrower and the lender.
- P2P platform cannot provide any kind of principal or returns guarantee. That means risk of lending is exclusively yours (i.e., lender’s).
- P2P platforms are required to register with all the Credit Information Companies (CIC) such as CIBIL and furnish credit information to the CICs on a regular basis. (As a borrower, if you thought you could escape a hit to your credit score in case of a default, you are wrong.)
- As I understand, P2P cannot facilitate secured lending from its platform. You will get (or give) only unsecured loans.
- A P2P platform cannot lend on its own.
- The interest rates displayed on the website shall be in Annual Percentage Rate (APR) format.
As a lender on the platform, you are entitled to details about the borrower including personal identity, required loan amount, interest rate sought and credit score (as determined by P2P lending platform). As a borrower, you will get details about lenders’ proposed loan amount and interest rate offered. You are not entitled to personal identity and contact details of the lenders. Here is the funds transfer mechanism as per the RBI circular.
If You Are a Borrower
Be prepared to pay a very high rate of interest. When I checked some of these websites, I couldn’t find interest rates below 20% p.a. These websites claim to facilitate from 12% p.a. to 30% p.a. The interest rate will depend on your credit rating and your nature of employment. These P2P lending platforms may use internal rating methods too. Do note these platforms are marketplaces. You will probably quote the rate you are willing to borrow at. Lenders will decide if they want to lend at that rate given your credentials. If you don’t find enough lenders, you may have to increase your borrowing rate.
Clearly, if you can can get a cheaper personal loan from Banks/NBFCs, there is no reason why you should opt for loans through such platforms. Moreover, interest is not the only cost. P2P platform will have its cost too. I checked the fees & charges by Faircent and i2iLending. P2P platforms are charging up to 3-8% of the loan amount as the processing fee. The processing fee depends on the creditworthiness of the borrowers. This is huge by any standards. As I see, these costs could also be higher due to lower loan amount and other operational expenses. You may also be asked to pay for loan insurance that is likely to add up to the cost. An upfront processing fee and the insurance cover cost will shoot up your actual borrowing cost much higher. You need to see if you can repay the loan.
If you manage to borrow and repay the loan, it helps improve your credit score. An improved credit score could help you get a loan from traditional lending institutions (banks and NBFCs) at a later date. However, if improving your credit score is your only goal, you are better off getting and repaying a secured loan (Loan against FD, Loan against LIC Policy, Gold Loan etc.).
If You Are a Lender
If you are a lender and you can see the exorbitant overall cost for the borrower, it is not always something to be happy about. Don’t forget you are lending to a person who is already financially stressed. And when you lend, you want to get your money back. P2P lending platforms will rate borrowers based on their proprietary (internal) rating methods. This information may be useful to you before you decide to lend to specific borrower. Clearly, higher the credit rating of the borrower, lower the interest rate.
If you are planning to lend money through Peer-to-Peer lending platform, here are a few things you must keep in mind.
- The money relationship is between you and the borrower. The P2P platform has limited role to play in terms of documentation and exchange of funds.
- In case of a default, it is between you and the borrower. P2P platform may help in following up but it can’t reimburse your loss or share legal costs.
- If someone is willing to borrow money at 20% p.a., you must understand he/she must have exhausted all the cheaper options to borrow and must be desperate to borrow.
- In my opinion, the odds are stacked against you to begin with.
- However, at the same time, you get the reward in terms of high interest rate. You need to see if the reward is worth the risk.
- If you want to take the risk, it may be prudent to divide your lending between different types of borrowers (borrowers with different credit ratings). That way, you will be able to diversify some of the borrower risk.
- Don’t simply pick borrowers that are willing to borrow at the highest rates. Understand the risk of non-payment involved will be the highest for such borrowers.
- The interest income from such lending provides a monthly cash flow, but will be taxable.
- Although you may think of this as another option for investing your surplus money, liquidity is a big issue here. Once you lend your money, it could be gone for up to 3 years. You cannot “cash out” in case of emergencies. The lender has very little recourse if suddenly there’s high default rate due to economic turmoil and high unemployment. While I wouldn’t ask you to stay away from such P2P platforms, you must understand it is a high risk investment. You must see if you have the requisite risk appetite.