Everybody talks about the win-win situation p2p lending offers for lenders and borrowers. By cutting out the large spread a bank takes when making a loan, the lender can get a higher interest rate, than he might in a savings account and the borrower may get a lower interest rate, than using his credit card. But who does actually decide what the interest rate for a p2p loan will be?
Several market mechanisms have developed. P2P lending services use combinations of these to built their platforms. I’ll describe some of the elements:
Individual Loan Listings vs Markets: With Listings (e.g. Prosper, Lending Club, Auxmoney, Isepankur) lenders can look at individual loan listings and see multiple parameters (e.g. credit grade, income, DTI, occupation, location,…). The lender can select (“filter”) loans based on his strategy. This is not necessarily a manual process as he can opt to use automatic bidding tools that make the selection for him based on criteria he set in advance. Other p2p lending services use Markets (e.g. Zopa, Ratesetter) which combine loans based on broader criteria (e.g. loan term, or credit grade). Here a lender can only decide which market to invest into, but does not pick individual loans.
Close at Funding vs Auctions: Some p2p lending services close loan listings once they are 100% funded. The loan is then originated. Others uses an auction process where the listing is open for bidding for a set time. If the loan amount is 100% funded then the bidding continues for the remaining auction period. New bids at lower interest rates push out old bids at higher interest rates, thereby lowering the final interest rate for the borrower. Some p2p lending services allow loan listings of both types or let the borrower prematurely end an auction (e.g. Rebuildingsociety, Isepankur, Assetz Capital).
Uniform vs Mixed Lender Rates: After an auction the interest rate for the borrower can be set at the rate of the highest successful bid. In this case all lenders on the same loan get the same uniform interest rate (e.g. Isepankur). Another option is to calculate the interest rate as an aggregate of all successful auction bids. In this case each lender gets the rate he did bid – there will be a wide mix of lender interest rates on the same loan (e.g. Rebuildingsociety).
Who does decide what the interest rate will be on a p2p loan
I. Borrower sets interest rate
The borrower decides, what (maximum) interest rate he is willing to pay (e.g. Smava, Auxmoney, Isepankur). The lenders can then decide, if they want to fund this specific loan at that rate or not. If there is an auction and lender demand is strong, then the borrower may get the loan for a lower interest rate then specified. Obviously lenders will fund loans with most attractive rates first and other loans will go unfunded. These borrowers can react by relisting at a higher interest rate. Continue reading