Lending With Peer-to-Peer Platforms: An Introduction

Growing your wealth at the rate of 5% or more can seem like an impossible dream in the current low-interest environment. A quick look at the moneyland.ch savings account comparison shows that Swiss banks pass on anywhere from 0% to around 0.5% in annual interest to investors. At the same time, banks charge anywhere from 4.5% to 9.9% in annual interest (up to 12% for credit card loans) for the use of the capital, as shown by the personal loan comparison. That means banks are making a huge profit on the money they borrow from investors.

Banks have been able to do this because up until now, there have been few practical alternatives for low-risk, passive investment and for connecting with potential borrowers. But technology is opening up new opportunities. Peer to peer lending (P2P) platforms can now accomplish the same task as banks – connecting people who need money with people who have surplus wealth which they want to invest.

Swiss peer to peer platforms allow lenders to earn interest in the range of 1.50% to 10% on their investments, depending on their risk capacity and the platform used. You can request a detailed breakdown of the costs and yields of Swiss P2P platforms at the foot of this guide.

What is peer to peer lending?

Peer to peer lending, as the term is used today, refers to loans provided directly by investors to borrowers, much like private loans. The main difference is that peer to peer loans are typically brokered through an intermediary which connects the two parties. In the past, peer to peer lending platforms were limited to brokers or exchanges which were few and far between. Today, intermediaries are primarily online peer to peer lending platforms. But the aim of peer to peer lending remains the same: to bypass banks and deliver a greater share of profits to investors.

How does peer to peer lending work?

Peer to peer (or P2P) lending works a lot like private lending to friends and acquaintances in that investors lend money directly to borrowers rather than investing in a bank which lends money to borrowers. Online P2P portals acts as brokers, bringing borrowers and investors from all parts of the country together in one place to do business. As an investor, you can lend directly to borrowers and keep the bulk of the interest payments made for yourself.

A number of different models are employed by different peer to peer lending platforms. Some platforms require investors to finance a loan in full. However, the crowdfunding model – in which any number of investors jointly finance loans – is the most commonly used model.

Typically, loan applications from prospective borrowers are screened by the peer to peer lending platform to determine their creditworthiness. This is one of the most valuable services provided by these platforms. Loans are then listed on the platform as projects. Some platforms allow the borrower to state how much interest they are willing to pay for a loan within certain limits. This allows borrowers to offer above-average interest as an incentive to lenders. It also allows borrowers to offer interest which is lower than market rates but may still be attractive to private investors.

Investors can decide which projects they want to finance, and how much they would like to invest in the project. Some platforms require a minimum investment to participate in a project (1/20 of the full loan, for example). If and when the full amount required is committed by investors, the peer to peer platform delivers the loan to the borrower.

What should you consider before investing in peer to peer loans?

1. Yields. Knowing the minimum and maximum interest which can be earned on a platform can help you to calculate the average yields you can expect to earn based on your risk tolerance. The maximum interest rate of 10% stipulated by the Swiss consumer credit law is generally used by peer to peer loan platforms for personal loans, while business loans may have higher interest rates. The minimum interest rate varies between platforms. Interest rates shown to borrowers often include the administrative fee and insurance premiums (when applicable), in which case the interest you earn as the lender is somewhat lower.

2. Fees. Platforms generally charge borrowers an administrative fee for their service (typically between 0.5% and 1% of the full loan amount for each year of the loan term). In exchange for this fee, platforms manage the transfer of loans to borrowers and collect loan repayments and interest on behalf of investors. Some platforms charge a just one fee for each investment, while other charge an annual fee each year of a loan term. Make sure to carefully calculate the total potential cost of fees before investing through a platform.

3. Risk. Investing all your capital into a single loan exposes you to a lot of risk. If that one borrower goes bankrupt or defaults for any other reason, you could lose all outstanding capital. A better strategy is to divide your capital between a large number of loan projects so that if one borrower defaults, you only lose the money you invested in that one loan. The more high-risk loans you can add to your portfolio, the more you will earn in interest – but the risk of losing money is also higher. You can balance your P2P lending portfolio by investing in both low-risk loans which deliver lower yields, and high risk loans which deliver high yields, so that you achieve a good rate of return without taking on too much risk.

There is also a risk of a peer to peer platform going bankrupt, particularly because many of the service providers are not yet firmly established. As a general rule, you as the lender retain the claim to repayment of the debt over the borrower even if the broker (the P2P platform) goes bankrupt. However, the terms and conditions of the P2P service provider and your specific loan contracts will determine your legal claim to repayment of debt in the case of platform closure.

4. Investment options. Peer to peer lending in Switzerland is still in its early stages. Depending on the platform you use, you may find a fair number of projects available for investment at any given time, or you may find just one or two. If you cannot find enough projects to properly balance your P2P lending portfolio on a single platform, consider dividing your capital between projects on several different platforms.

5. Minimum investment requirements. Some platforms require that you invest a minimum amount of money (1/20 of the loan, for example) in order to participate in a project.

6. Liquidity. Your life and financial situation is subject to change. When you invest in long-term loans (5 years, for example), you should consider whether or not there is an option to close the position and recover your capital prematurely if need be. Some platforms include secondary marketplaces on which investors can sell their debt claims to other investors, which is a good option to have in case you want or need to recover your capital ahead of schedule. Some platforms charge a fee when you sell a debt claim on the secondary market.

7. Insurance. Some platforms require borrowers to take out payment protection insurance. Coverage may be limited to defaults caused by death (term life insurance), or it may cover defaults caused by unemployment and disability as well. Some platforms offer optional payment protection insurance, but do not require it. Payment protection insurance greatly lowers the risk of default. Platforms which do not require insurance may indicate which borrowers are insured so that you can make an informed investment decision. Premiums are paid by borrowers, not by you as a lender.

8. Depositor protection. Peer to peer lending brings much more risk than depositing money in a savings account or buying medium-term notes because you do not benefit from depositor protection. Platforms may operate accounts for the purpose of distributing your investments and collecting repayments and interest on your behalf, and asset held in these accounts benefit from depositor protection. However, these are transit accounts, and assets are only held in them temporarily before being distributed.

9. Investor protection. Some platforms provide an additional layer of protection against loss in the form of mutual insurance. Creditgate24, for example, uses a system based on solidarity, in which losses incurred through a loan default are collectively borne by all investors funding projects in the same risk category. This is beneficial if a borrower defaults on a loan which you invested it because you lose less. Example: 80 investors on the platform invest in average credit loans. You and 10 other investors finance a 60,000-franc loan to an average credit borrower and that borrower defaults on 50,000 francs. Each of the 80 investors must cover an equal portion of the loss – or 625 francs each. The downside is that you, in turn, may have to cover losses for loans which you did not invest in. The benefit of these schemes depends largely on the number of investors who participate in the corresponding platform.

10. Residence requirements. Some Swiss P2P platforms require investors to be resident in Switzerland, while others accept non-residents who work in Switzerland and still others only require investors to have a Swiss bank account. When choosing a P2P platform to invest with, consider whether you may leave Switzerland in the future.

Investing outside of Switzerland

The Swiss P2P lending marketplace is still in its fledgling phase. Currently, investment opportunities are not bountiful so opportunities to invest large amounts across multiple Swiss borrowers are limited.

An alternative for those with higher risk tolerance is investing in P2P loans outside of Switzerland. German P2P portals like Auxmoney and Crosslend have similar fees and returns to Swiss P2P lending portals, but benefit from a larger market. U.S. P2P lending platforms like Prosper and Lendingclub benefit from one of the largest established P2P markets. The problem is that in almost every case you will need a local bank account in the relevant country. In some cases, a local social security number may be required.

A handful of P2P platforms such as Relendex in the U.K. and a number of P2P platforms in Eastern Europe do make allowances for non-resident foreign investors. It is important to understand that when you invest in another country, your investment will be subject to the regulations, financial and consumer protection laws, bankruptcy laws and tax laws in that country. You should also check into costs and limitations related to transferring money to and from that country, including currency exchange fees.

More on this topic:
Personal loan comparison
A basic guide to crowdfunding in Switzerland
Guide to real estate crowdinvestment in Switzerland
Crowdinvestment – a guide for Swiss investors
Peer to peer loans in Switzerland