What will a rate rise mean for P2P lending?
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!
Main image "Mark Carney" by Financial Stability Board. Image subject to copyright. A link to the image and appropriate licence can be found here. You must not use or reproduce this image other than in accordance with the licence.
- Quick guide to how our interest rates work
- Innovative Finance ISA: The good and the 'bad'
- The ultimate guide to your first P2P investment
Get email updates for future blogs:
There is barely a week to go until the conclusion of the 2017/18 financial year, which means that, as ISA season begins to hot up, time is running out to take advantage of your ISA allowance.
At the Summer Budget in 2015, George Osborne had multiple nuggets of good news for investors in peer-to-peer lending (P2P), most notably the announcement of the new Innovative Finance ISA (IFISA).
Over the last decade, there can be little dispute that the reputation of mainstream banks – and particularly the so-called ‘Big Four’ (HSBC, Barclays, Lloyds and RBS) – is at its lowest ebb.
The peer-to-peer (P2P) lending industry is now regulated by the Financial Conduct Authority (FCA). The regulatory framework has been designed to protect customers and promote effective competition.
Loan underwriting is the process that we undertake to analyse all of the information provided by each loan applicant and their credit file to assess whether or not that applicant meets our minimum loan criteria. As part of that process all data is verified, analysed and summarised to paint a picture of each applicant.
When you earn interest from a regular bank savings account, for example, the bank automatically deducts basic rate tax (currently 20%) before paying your interest. With interest earned from peer-to-peer lending, tax is not deducted automatically so lenders will need to declare their income to HMRC.
As 2018 draws to a close, with our bellies full of Christmas turkey, it's only natural to look back on the past 12 months and reflect. No doubt, it's been a turbulent one economically and politically, and not everyone has had it all their own way.