What is peer to peer lending?

P2P lending ('Peer to peer' lending) is a means of connecting finance-seeking consumers with a private lender, with the potential to extend finance at a lower interest rate than the big banks.

An example of the shared economy and also referred to as marketplace lending, P2P lending is exemplified by any online intermediary for consumers borrowing directly from investors. The investor could be an individual or a corporation, and the borrower bypasses banks, credit unions and building societies. Apart from the prospect of negotiating lower costs, P2P may suit a borrower with a poor credit history if the borrower has had difficulty arranging finance through a traditional lender.

Peer-to-peer loans can suit a variety of purposes, including a personal loan, a car loan, a home loan, property development or business funding. Obviously, the personal loans and car loans are of most interest to consumers in the market for a new or used car.

Historically, when buying a car, there were four options: pay cash, obtain finance from the dealership, take out a loan from the bank or rent-to-own, the last often known as corporate or commercial hire purchase – a borrower makes repayments while using the car, but ownership remains with the company providing the finance until the end of the contract.

But there are other options when it comes to taking out a loan (be it a car loan or a personal loan). Not least of those options is P2P.

With the banking royal commission now concluded, finance is at the front of mind for many borrowers as they consider the various avenues open to them for finance.

And many people are contemplating alternatives to banks when it comes to car finance, with 31 per cent of respondents to a recent survey by Canstar saying they would consider car finance from a non-bank lender to finance their car – an option such as peer-to-peer lending – or else they have already entered into such a contract.

The P2P lending platform is essentially a marketplace where a private investor can make a borrower an offer for a personal loan or other type of finance. This could mean a lower interest rate and reduced cost for a savvy borrower.

For a borrower with a poor credit rating and unable to lock in a loan elsewhere, there could be an investor willing to lend to the borrower, although this could involve higher rates and fees than more traditional lenders would normally charge.

Before taking out a personal loan through a peer-to-peer lending platform, always compare the offering with what might be available to you through traditional sources and thoroughly read the product disclosure statement. If in doubt, seek advice.

What are the potential downsides?

While peer-to-peer lending can provide a cost-effective option for some, there are a few possible risks involved. For a start, there is no guarantee there will be an investor available to lend the money and some platforms could have an undersupply of investors.

If you contact a standard financial institution it will generally be able to assess you for a loan based on set criteria. With peer-to-peer lending, however, it all comes down to whether an investor is available and whether they are satisfied with taking on the risk of investing (lending money to the borrower).

Regardless of which finance option you are considering, it is a good idea to get a solid understanding of your options before you start looking for a car. Some of the main things to keep in mind include:

1. What is your budget? In other words, how much do you know you can genuinely afford to spend on your car? It's a much better idea to purchase a car that suits your budget rather than arranging finance to suit your car ownership dreams. Remember to factor in registration, petrol costs and car insurance.

2. Do you have money saved up you could use to pay for the car up front and avoid taking out a loan?

3. What is your credit score? If you don't know, a number of websites offer a free online check. If you have a poor credit score, you may need to work on improving it before a financial institution will lend you the money. A poor credit score often results in a higher interest rate from an investor.

4. How would you prefer to arrange your finance, if you decide to take the car loan route? There has been an increase in online-only lenders as well as lending platforms where you may be able to find competitive rates (due to the lower overheads these providers typically face compared to banks and other traditional financiers). However, if you would rather speak to your provider face-to-face, you may prefer a financial institution with a physical branch.

5. Shop around. Regardless of which institution or platform you would usually favour, it is a good idea to compare a number of peer-to-peer lending options to find the best deal for you.

Buying a car can be a pretty serious financial commitment, yet one most of us in Australia will undertake at some stage of life.

According to the Australian Bureau of Statistics, Aussies spent a total of $65.8 billion on cars in 2016, and the amount we're spending is increasing. In 1997 we spent $8.9 billion on car loans, increasing to $16.3 billion by 2017.

Unsurprisingly, with this increase in spending has come an increase in the financing options available. According to ASIC (Australian Securities and Investments Commission), peer-to-peer lending has underpinned $300 million worth of loans in Australia in the 2016/2017 financial year, increasing from $156 million in 2015-16.

Disclaimer: This advice is general and has not taken into account your objectives, financial situation, or needs. Canstar is an information provider and is not making any suggestion or recommendation about a particular credit product or loan. Consider whether this advice is right for you. Consider the provider's loan documentation before making any financial decision. For more information, read Canstar's Financial Services and Credit Guide (FSCG).

About the author: Josh Sale is a Senior Research Analyst at Canstar, responsible for the continued methodology development and delivery of Canstar's flagship Star Ratings. Josh is tertiary-qualified in economics and finance, and transforms millions of rows of calculations into a consumer-friendly Star Rating.