When someone seeks to hand me a flyer at the train station or on the Tube I normally pretend not to notice. But this week, for some reason, I grabbed the piece of card being waved in my direction. It was more interesting than the usual offer of 25p off a sandwich or £50 off the joining fee at the local gym.
The card was for a company called Zopa (www.zopa.com) which seeks to bring together borrowers and lenders without requiring them to go through a bank or other financial institution. Zopa was launched earlier this year. Its business model is relatively simple.
If you are looking to borrow money you post your details on Zopa’s website indicating how much you want to borrow and over what period you are looking to pay the money back. Zopa will then analyse your financial situation, giving you a credit rating according to your perceived ability to continue meeting the loan repayments.
It claims that by using this model not only can it give most borrowers a much more competitive rate for loans than they could get off the high street but that people who lend money via Zopa will also get a much better return than had they stuck their cash in a bank account.
Of course there are risks. But before we take a closer look at these, let’s take a look at the Zopa rates that are currently available.
Under the Zopa model, the rate charged by the lender is exactly the same as the rate incurred by the borrower. In short, Zopa does not take a cut as an intermediary.
The average interest rate for borrowers and lenders on Zopa is currently 7.3 per cent but this figure will vary according to the borrower’s credit rating and the period of the loan.
Currently, someone with Zopa’s top “A” credit rating who is looking to borrow £1,000 over 12 months will pay just 5.1 per cent in interest, much more competitive than the best personal loans on the market. According to Moneyfacts, the best personal loan rate for £5,000 over three years is 5.7 per cent.
Borrowing £5,000 over three years with a “B” rating, the bottom credit rating score from Zopa, would cost 8.5 per cent. This is worse than the headline rates advertised by many personal loans but remember that headline advertised rates are not available to all.
If you are a lender, these returns stack up pretty well against the best savings accounts, particularly if you are willing to take on the extra risk of lending to people with a “B” credit rating. And as a lender, remember you will get the same return as a borrower.
I can hear you asking: “So how does Zopa make its money?” Well it is looking to two main revenue streams.
One is by selling payment protection insurance (PPI) to some borrowers. In the event that the borrower is unable to meet repayments because of illness or redundancy, this insurance will cover the loan repayments. And from next year, it will also start charging borrowers an upfront fee of 1 per cent of the value of the loan. There will be no fee charged to lenders.
Even after this fee, borrowing from Zopa may still make sense for some people, particularly those with decent credit ratings.
But for lenders, the risks are less clear cut. As a lender to Zopa you are taking on all the default risks of the borrower. So if the person you are lending to is unable to meet the loan repayments you risk losing out. Zopa seeks to minimise these risks in a number of ways.
First, it conducts credit checks on its borrowers with three separate agencies. It also asks them an array of questions about their financial status.
Second, all loans are spread across 50 different borrowers with the same credit scores. So, in the event of one customer default, the maximum a lender could lose on a £5,000 loan is just £100. And in reality the loss on just one default would likely be much less as the borrower would probably have already made several loan repayments. In the event of a default, Zopa will also send out a debt collector on your behalf.
The other risk is that Zopa itself goes under. Zopa insists that it has enough cash to see it through to profitability and, in the unlikely event that it did collapse, it has also set aside enough cash to continue acting as an intermediary.
This is of some comfort. But if you are lending via Zopa, you should be getting a much better return than you would from cash to compensate for these unknown risks.