The word “disintermediation” is not very common in a financial advisor‘s vocabulary. Typically, financial advisors work with intermediaries like banks and other financial institutions when managing their client’s finances. So what happens when a financial phenomenon starts to take over the social media world that essentially removes the need for an intermediary? The loan and investment service known as peer-to-peer lending is changing the financial lending landscape in drastic new ways.
What if I told you that your clients could borrow money from a complete stranger, receive better interest rates than what most banks offer, and give the lender the opportunity to yield higher returns, all within a much shorter time period than the average loan and investment process? This is exactly what peer-to-peer lending does.
Peer-to-peer lending, also known as person to person lending and social lending, is a specific type of financial transaction that occurs between individuals without the intermediation of a traditional financial institution.
The removal of traditional financial institutions results in a drop in costs for servicing customers. It is important to point out, however, that as the peer-to-peer lending process develops, and more and more peer-to-peer companies that provide customer service, arbitration, product information and quality website management are created, we will simply see a reintermediation, much like the banks and traditional financial institutions we have been discussing. Furthermore, it is not crazy to foresee the reintermediation of peer-to-peer lending from financial advisors themselves-that is if advisors jump into the game and start playing for their clients.
As far as peer-lending companies go, there are numerous businesses out there. Think of these companies like a loan auctioning eBay website. Individuals looking to borrow money can go to the website, enter the amount of the loan, and in turn receive possible interest rates from different investors. Conversely, individuals interested in investing can invest as little as $25 per borrower, with the intent of small risks invested in a spread-out, well-diversified class of borrowers. Welcome to the new portfolio asset class! But is at as good as it seems?
Financial advisors and investment specialists should caution their clients in considering peer-to-peer lending. Why? Here’s a list of pros and cons to each:
- ? The elimination of a third party makes the process quick and easy.
- ? Auction-like style of borrowers offers the lender the ability to choose own terms and rates.
- ? Lenders can enjoy higher returns, and borrowers enjoy similar cost advantages.
- ? Less discriminate than banks. After the bank collapse, banks are cutting back on loans are upping the financial requirements.
- ? High risk of loan default, with little recourse for non-payment.
- ? Peer-to-peer loans are not subject to the same financial regulations as banks, so the loan terms may not be as favorable.
- ? Peer-to-peer loans can hurt your personal credit score.
- ? Less discriminate than banks, which means you may be loaning money to an individual unable to pay you back.
As you can see, peer to peer lending has its definite advantages and drawbacks. Investors should be extremely wary about recommending peer-to-peer lending to their clients, and if they do, make sure you’re doing your homework. Develop a comprehensive system of investing in borrowers based on information that is available about the borrowers. Make sure to do some in-depth research on peer-lending companies, too.
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Amy McIlwain is a professional speaker on social media and president of Financial Social Media, an online marketing firm specializing in the financial industry. She can be reached through her website at www.financialsocialmedia.com and on Facebook, LinkedIn, and Twitter.