It’s important to understand that peer-to-peer (‘P2P’) lending companies are middlemen. Their principal goal is to connect investors with credit-worthy borrowers.
In a perfect world, this three-party scenario works well for all parties.
- The investor benefits from an interest rate exceeding those on offer from traditional bank savings accounts (albeit with higher risk, as no FSCS protection applies).
- The borrower often benefits from lower interest rates and quicker lending decisions than those achievable via traditional high-street banks.
- The P2P platform benefits from matching the two parties. Each platform has its own distinct fee structure, but there are common trends in the ways that fees are generated.
P2P platform fee structures
The first way in which P2P platforms profit is via initial ‘arrangement’ or ‘setup’ fees charged at the start of the loan. These fees are exclusively paid by the borrower and reimburse the platform for its costs in sourcing/reviewing the loan and providing access to its investors.
The vast majority of firms charge such a fee, with very few exceptions (e.g. Growth Street). For those that do, the fees can be as high as 6.0%. Not all firms publicly declare the fee range unless you are applying for a loan, though some examples are listed below:
- Assetz Capital – Between 2.0% and 5.0%
- Funding Circle – Between 0.9% and 6.0%
- Crowd2Fund – 6.0% fee on first £500,000 and 2.5% for funds raised after that
- ThinCats – 1.5% for non-underwritten loans, 2.5% for underwritten loans
- LendingCrowd – Between 2.0% and 5.0%
- Archover – 4.8%
- Crowdstacker – Up to 5.0%
- Folk2Folk – 2.0%
- Unbolted – 3.0%
- Loanpad – 1.0%
- CrowdProperty – Between 3.0% and 4.0%
Throughout the life of a loan administered by a P2P platform, the platform will earn a ‘margin’ on the interest rate charged to a borrower and the interest rate paid to an investor. For example, the borrower may be lending at 6.5% interest rate whilst the investor is paid 5.5% interest.
Firms have multiple ways of charging this fee. The majority of platforms declare that investors pay no fees, with borrowers incurring the cost of their operations (i.e. via a ‘service fee’ which is added to the cost of borrowing, raising the interest rate ultimately paid). However, certain firms do charge both the investor and borrowers. Therefore, it is important to read the platform FAQ’s to understand whether or not the expected interest rates quoted are net of fees.
Comparing P2P platform fee structures
Unfortunately, it is not easy to compare the overall margin taken by the P2P platforms. This is because not all platforms are transparent about the margin they are taking for commercial reasons. As the FCA pushes for more and more transparency in the P2P lending sector, I envisage a scenario in which platforms are forced to declare this information.
Why might this information be useful to investors? Well, higher interest rates generally mean higher risk. The larger the margin taken by the P2P platform, the lower the return to investors.
For example, imagine a borrower who approaches a high street bank and two different P2P platforms for a £100,000 loan:
- High Street Bank quotes an interest rate of 8.0%
- P2P Platform A quotes an interest rate of 7.0%
- P2P Platform B quotes an interest rate of 7.0%
Assuming the arrangement fees of Platforms A and B are identical, the borrower may opt for either one. Depending on which platform is selected, the loan will be offered to a different investor group:
- Platform A offers the loan to investors at an interest rate of 6.0% (taking 1.0% margin)
- Platform B offers the loan to investors at an interest rate of 5.0% (taking 2.0% margin)
Over the course of the year, a retail investor placing £1,000 into this loan would earn £60 in interest from platform A, but only £50 in interest from platform B. The risk has not changed for the investor, but the potential return has. Investing in platform A would result in 20% extra profit.