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What Will A Rate Rise Mean For P2P Lending?
We were just pondering that question when we noticed Lending Works‘* recent blog on this exact same subject. Here it is, written by Mike Todt. It's worth reading to the end. Beneath it is my own (Neil Faulkner here) brief, candid opinion.
A few weeks ago, Bank of England Governor Mark Carney confirmed that the days of 0.5% borrowing costs are numbered. Although the change to the Bank of England base rate is unlikely to be immediate, Carney suggested an increase in the next six months was probable. It would represent a first change in borrowing costs since March 2009, and Carney added that the base rate will likely peak at just over 2% in the ‘medium term’.
Although such a figure is barely half the historic norm since the Bank came into being in 1694, the fact that many homeowners have never experienced an increase on their monthly mortgage repayments has sparked something of a re-mortgage frenzy.
Yet while some feathers may have been ruffled among borrowers, those in the long-suffering savers camp will be relieved. In simple terms, an increase in the cost of borrowing equates to better returns on savings. Poor earnings on low-risk investments and money in the bank have become commonplace in recent years, and while this has largely coincided with low rates of inflation, maximising wealth has been hard going since the recession.
Rates and peer-to-peer lending
Of course, such a market has very much opened the door to peer-to-peer lending (P2P), and those willing to take a small leap of faith in terms of risk by lending money directly to borrowers have benefited from returns often in excess of 6%.
Yet what will the rate increase mean for peer-to-peer lending, which has hardly known a world without a 0.5% base rate? After all, banks will be able to offer better rates on savings in the event of a rate rise too. And as the costs of borrowing money rise, will P2P platforms still be an attractive proposition to prospective borrowers?
Making predictions is far from an exact science, and hindsight could well prove to be more accurate than foresight. But interest rates will of course affect both lenders and borrowers who make use of peer-to-peer platforms. Returns for those who lend money will be boosted, while those seeking a loan will likely make repayments at a higher Annual Percentage Rate (APR).
So will this create a market skewed too heavily in favour of lenders, resulting in an imbalance of incoming lending capital with demand from borrowers? Or will the wave of funds moving towards lending through P2P abate, given that keeping money in savings accounts will be more beneficial than before?
The answers to such questions will be less dependent on the behaviour of peer-to-peer lending platforms, and more down to the response from banks and other high-street financial institutions. One thing that consumers can safely depend on is the agility and efficiency of P2P, and, from a lender perspective, this will allow them to derive the full benefits when rates go up.
It would be a surprise if the interest rates offered by banks to savers didn’t improve too, but to what extent will this reflect proportionally in their customers’ pockets? History offers us compelling evidence that at least some portion of these improved ‘margins’ will end up in these high-street heavyweights’ profit column, and should this be the case, the prospect of alternatives can only become more appealing. Put the shoe on the other foot, and borrowers seeking loans can expect no favours from banks. APRs will go up at least in proportion to the rise in base rates, while some may well be inclined to steal a yard or two and charge a significantly higher rate to those taking out a loan – using the guise of the rate change as justification.
Such prophecies may sound theoretical, but there is a considerable degree of historical evidence to back them up. What’s more, banks, as the established guard, rely heavily on consumer inertia, with many simply accepting their fate in terms of the poor value they offer without seeking alternatives.
Complacency is the enemy
It’s no time for P2P platforms to become complacent though. One universal truth is that higher interest rates are typically associated with higher borrower default rates on loans across the board, particularly across loan books with a high proportion of mortgaged homeowners and those with variable rate debt. For banks, and, more specifically, those with money in the bank, this is no great cause for concern. But for peer-to-peer lenders, it is definitely something to be wary of.
Yet provided underwriting standards are upheld, reputable platforms need not experience a major spike in borrower default. Most importantly, in relative terms, there is no reason to believe either borrowers or lenders will be any worse off when Mr Carney eventually decides to give the rates an upward nudge. What will be fascinating to see is whether the reputation of peer-to-peer lending actually ends up being enhanced ever further. Call us optimists, but we have every confidence this will be the case!
Opinion from 4thWay's Neil Faulkner
The two important factors are a) how much you earn over inflation and b) how high are bad debts?
It's fine to be earning “just” 5% to 6% if you're comfortably beating inflation by lending to very low risk borrowers with low bad debts.
It's less fine to be earning 12% if you're fighting hard against inflation and/or your borrowers are less than tip top and your bad debts are skyrocketing.
No one can say what will happen when rates rise, but the best thing individual lenders like you and me can do is keep lending and re-lending, to a) ensure you're constantly taking advantage of the higher rates and b) to ensure that you're not lending all your money at one point in time, which means that your borrowers – and therefore you – are not all hit by a terrific event at once, such as a rapid rise in interest rates and an accompanying recession.
It pays to be cautious in this high debt world, where interest rates could rise suddenly and far more rapidly than economists predict. (Let's face it, their forecasting record is atrocious.)
So stick to low-risk lending and spread your money across P2P lending websites targeting that area, such as Lending Works* itself, and RateSetter, Zopa, Landbay*, Wellesley & Co.* and Funding Circle's A+ loans*. These all allow you to contribute as little as £10 to £20, which is usually split again among dozens of borrowers.
Will savings be more attractive in a high interest rate world? Probably not if they continue to give you a loss after inflation. Remember – that means you're getting poorer despite the higher rates.
*Commission, fees and impartial research: our service is free to you. 4thWay shows dozens of P2P lending accounts in our accurate comparison tables and we add new ones as they make it through our listing process. We receive compensation from Funding Circle, Landbay, Lending Works, RateSetter and Wellesley & Co., and other P2P lending companies not mentioned above either when you click through from our website and open accounts with them, or to cover the costs of conducting our calculated stress tests and ratings assessments. We vigorously ensure that this doesn't affect our editorial independence. Read How we earn money fairly with your help.