Zopa: The future of lending?

The social-lending website, Zopa, is a marketplace where people lend and borrow money from eachother. Zopa was the world’s first social lending and borrowing marketplace website, and its success has spawned many copycats across the globe.

So how does it work?

Zopa has two methods of lending: the market or via listings. The marketplace is split into 5 distinct markets (A*, A, B, C, Y), each with loans of 36 or 60 month durations. Lenders set-up offers through the Zopa interface specifying which markets and durations they wish to lend in and the rates they want to charge. When a borrower requests a loan, they are assigned a market rating based on their credit worthiness, and Zopa matches up the loan amount with offers from lenders, and the weighted average of all the matched offers is what defines the loan’s overall interest rate. Once the offers are matched, Zopa employees conduct further checks on the borrower, and if the borrower is deemed to not be a high enough credit worthiness for that market then the loan is rejected and the lender’s money moves back to the marketplace. [See here for how the markets work]

Listings are a relatively new part of the Zopa website, “they work just like an online auction, except that the ‘price’ comes down instead of going up.” The borrower provides information about themselves and why they want the loan, they income and expenditure, and they are assigned a 5-star rating for ‘Credit Score’, ‘Affordability’ and ‘Stability’. Lenders, upon assessing the risks of the loan, set the rate at which they are prepared to lend. Once the loan has ‘bids’ in excess of the loan amount requested then only the ‘bids’ with the lowest rates are matched at the end of the listing (auction). [See here for more info]

How do Zopa make their money?

On every loan arranged through Zopa they charge a fee (currently £94.25) to cover the expenses of arranging the loan and checking the borrower’s credit worthiness. This is a one-off non-refundable fee, but there are no early repayment penalties.

Zopa also charge lenders a small fee on the amount of money lent out to borrowers. This is currently 1%, but for older lenders it is 0% or 0.5%. This is charged on a monthly basis.

Zopa’s Performance?

In the last few months Zopa have seen a massive increase in the number of borrowers and lenders, with over £2m on offer and a total of nearly 240k members at the time of writing. The constant flux in supply (lending offers) and demand (borrowers requesting loans) means that rates achieved are always changing. Current typical rates for each of the five 36month markets are as follows:

  • A* = 7.5%
  • A = 7.9%
  • B = 9.2%
  • C = 11.4%
  • Y = 11.7%

What about bad debts?

Zopa, having analysed historical data from a wide range of sources has given estimated bad debt values for each of the markets, as of writing the actual bad debt rates experienced have been much lower than the estimates. See chart for breakdown of estimated and actual bad debts across the markets.

Zopa Bad Debts - Actual and Estimated

Is Zopa the future of lending?

You can definitely argue that Zopa has come of age in the last year, down to many factors not least of which is the financial crisis and the resulting dislike of the banks. While banks have cut back their lending practices and raised interest rates on loans, they have also been cutting the interests rates they give on people’s savings, both of which drive people to seek alternatives, and Zopa has attracted borrowers and lenders for those two respective reasons. One large aspect is also the “human factor” where lenders and borrowers prefer the fact that they are both dealing with real people. Indeed some lenders offer funds at rates so low that it might imply altruistic intent.

While Zopa and any other social-lending services are never going to grow to the same scale as the current banking sector, they are providing a viable alternative to their members, both in providing competitive loan rates and the returns achieved by lenders.

There is a nagging doubt in my mind though about how Zopa will stand up in the current recession. Will the bad debts rise beyond acceptable levels? Will there be enough lenders, willing to risk their money, to satisfy demand for loans? Will Zopa be able to cope with any increases in scale?

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