Pair-to-pair lending is an excellent opportunity for both borrowers and lenders to bypass the tradition lending stipulations of a bank, and access or provide funds at typically better interest rates than banks. That means more return than a term-deposit for lenders, and lower interest rates for borrowers. In other words? A win-win.

While this type of lending is considered 'safe', and if you're using a financial service such as Southern Cross Partners, is licensed and regulated by the Financial Markets Authority (the government agency that's responsible for financial regulation in New Zealand) - like with any type of investment, there are always a few risks to be aware of before deciding where to invest your money.

In this blog, we outline the key risks involved in peer-to-peer lending, as well as what we're doing at Southern Cross Partners to mitigate those risks for our lenders.

Knowing the Risks of Peer-to-Peer Lending

1. The Borrower

As with any peer-to-peer loan, at the end of the day, the repayments as well as interest collected is inherently dependant on the person who took out the loan making their repayments consistently until the balance of the loan is settled.

Naturally, this means that there is some risk involved in lending your hard-eared cash to an individual. For example, there's is always the (while albeit unlikely) possibility that the person, group or business that you lend to cannot make their repayments, or declares bankruptcy. It's important to note that to avoid this, at Southern Cross Partners there are a few key steps we put in place to ensure that investments are as safe as possible.

• When a loan is first provided, we undertake stringent credit checks to ensure that a borrower can meet their loan payments without creating hardship, and in fact we have a legal requirement to do this. This means by the time lenders are given the opportunity to fund a loan, the borrower has already passed all of our mandatory checks, mitigating the risks that they're unable to be relied upon to meet their payments.
• One of the biggest advantages of a Southern Cross Partners investment is that all of our borrowers' loans are backed by property security (ie. borrowers already have a mortgage and own a home). This means if anything unforeseen occurs, we have the means to recover the full loan amount from the borrower or on a mortgagee sale (not only for the principal that is owed, but also for all outstanding Interest and Costs).

Although these two factors go a long way to provide investment security and safety, the is always the chance that things go south. As a second layer of security, here's what we do in the situation where a borrower defaults or cannot replay their loan.

• A benefit of most peer-to-peer lending providers, as well as here at Southern Cross Partners, is having a team who is dedicated to direct communication with the borrower who can deal with problems that arise and reach a solution without you ever having to get in touch with the borrower yourself. This means that usually, most issues are resolved quickly and effortlessly.
• If we're unable to reach a resolution and the borrower doesn't pay, Southern Cross Partners may elect to make up any shortfall. If we do this, your payments will continue, unaltered, and we will collect any shortfall payments from the borrower. If we elect to not pay you the shortfall, you will be entitled to a portion of whatever default interest we collect on your portion of the loan, for the period that your investment payments are in default.

When it comes to registered and regulated peer-to-peer lending, there are a number of precautionary measures in place, as well as safety nets to ensure the process is secure as possible for both borrowers and lenders.

2. Economic Risk

The second risk to be aware with (again, as with any investment) is the external risk factor of the global economy. Typically, New Zealand has quite a strong and stable economy. However that's not to say that we are isolated and immune to other global issues from countries that have more fragile economies - especially if they are significant trading partners of New Zealand. 

The potential impact of failures or global recessionary forces should not be underestimated by us, but just how far reaching an impact this could have on New Zealand is hard to estimate or forecast. However, it is known that historically  negative impacts in the global market could mean the following for Kiwis:

• Change in housing demand and
• House valuations and sale prices
• National levels of unemployment
  
• Change in loan interest rates
• Value of the NZ dollar

While the short term nature of our lending/investments and the supporting registered mortgage over the borrower’s property may help to limit your exposure, the negative impacts described above could result in a shortfall in the loan repayment by the borrower (from a borrower default, negotiated lesser repayment amount of mortgagee sale) and you may not receive full repayment of your investment.

The change in the global economy is a risk that any investor takes when lending funds, investing money or even buying property takes.

3. Housing Market and Valuations

This factor is not always directly relevant to all peer-to-peer lenders, but in particular when investing or borrowing with Southern Cross Partners, every loan is secured by a registered mortgage. Naturally, this means that any change in house valuation as a result of damage to a property, market rates or LVR will effect the mortgage safety net.

• Placing a value on a property is not an exact science, and is always subject to change. Of course, there are professionals who are more qualified to make the call on how much a property is worth or likely to sell for, but values tend to change over time. Sometimes (anbd predominantly in recent times) these changes have been upward, but if the housing market changes, the values could go down. This means that there is always the possibility that a property that may have originally been a house worth $x may in time be worth y% less in time.
  If there are factors which negatively impact the valuation of a borrower’s property, this could result in us not being able to recover the full loan amount from the borrower if they are in default or on a mortgagee sale. Your investment may be impacted by any shortfall and you may not receive full repayment of your investment.
• The other risk to consider in terms of the real estate that your loan is attached to, is the possibility that the house is damaged. Fortunately, through Southern Cross Partners, there is an insurance cover in place - however there are some circumstances where an insurance may not be paid out. For example, a failure by the borrower to make adequate disclosure at the time of applying for the insurance, a lapse in  insurance cover because of a failure by the borrower to pay the premium, or if the damage is intentionally caused by the borrower.
  If the borrower owes more than the damaged property is worth then there is a risk that the loan will not be repaid in full and you will suffer a loss.

The good news is, it is within your power to select investments that you feel comfortable with, and that fit your own requirements and financial planning and in making your investment decisions you should remember that a negative impact on the market could result in a shortfall in the loan repayment by the borrower (from a borrower default, negotiated lesser repayment amount or mortgagee sale) and you may not receive full repayment of your investment.

The bottom line (and benefit of investing with Southern Cross Partners) is that you are able to select the location and the Loan To Value ratio that best suits your investment risk profile and investment strategy.

4. Interest Rate Changes

Presently interest rates are stable, and by historical standards, low.  But this will not always be the case, and you need to consider if you will be happy with the interest rate that you are locking into when you select the loan to invest in, if interest rates eventually start rising again. The main time that interest rates may affect you as a lender, is if you choose to re-sell your investment portion on the secondary market. For example;

• Whilst we offer a Secondary Market service for you to on-sell an investment, this may not be achieved if the new offerings available to investors are at a higher interest rate than the investment that you are trying to sell. You may therefore find that you are obliged to remain with the investment, at what may be a lower interest rate than other investment opportunities, until the loan is repaid.

5. The Failure of Your Peer-to-Peer Provider

An unlikely but possible risk of investing with a peer-to-peer lender is that Southern Cross Partners mismanages the business, and as a result, causes the business to fail. Fortunately, we're prepared for this situation and can confirm that there would be no risk to any investments, as the mortgage security and any funds associated with it, are kept separate from Southern Cross Partner’s business activities, in a Trust Company.

In addition to this precaution, we have a formal agreement with another experienced finance provider, who will take over the management of the business, to continue to collect and pay your interest, and (when the loan repays), collect and repay your investment principal.

If you have any question or are interested in exploring the risks and benefits associated with peer-to-peer lending before making a decision, feel free to get in touch with our team! We're happy to help.