Cut out the middleman: borrowing without the banks

There used to be a general feeling that banks were sturdy institutions, capable of weathering the strongest of financial storms, but the recent government bailouts have revealed their hidden weaknesses. Ever since, trusting your bank has been that little bit harder.

Mistrust has been heightened by a general consensus that banks will charge even loyal customers a fortune to borrow money and offer the lowest interest rates they can to savers. But what if you could cut out the banking middlemen?

In fact, this is the premise of social lenders YES-secure and Zopa (which stands for 'zone of possible agreement').

These are online loan markets that bring together members of the public who want to borrow from and lend to one another. It's a relatively new phenomenon: Zopa launched in the UK in 2005 and YES-secure only a few months ago.

In a recent moneywise poll, 48% of respondents said they hadn't heard of Zopa and only 10% have used it – but the arrival of YES-secure on the scene suggests the idea is gaining momentum.

So how do they work?

As a prospective borrower, you first subscribe to the website, where you are credit-checked (through Experian for Zopa and Callcredit for YES-secure).

If approved, you are then put into a category known as a 'market' which determines the interest rate you will pay on any future loans. The riskier you are deemed to be, the higher the rate.

You can then list how much you want to borrow and for what purpose – for example: "I need £1,000 to go towards a new kitchen".

Meanwhile, prospective lenders, who are also credit-checked, post how much they have to lend, the rate they're offering to lend it at, and the category of people they are happy to loan it to.

Loan amounts over £500 are spread over 50 borrowers to reduce risk. For example: "I will lend £50 over three years at a rate of 10% to A-rated borrowers."

Lenders can bid to lend to borrowers based on the listings, and the borrower can choose to accept each rate offered or decline it, in an online auction-style bid.

On top of interest, Zopa borrowers pay a one-off fee of £124.50, while those borrowing through YES-secure pay an £80 administration fee. Lenders pay a 0.96% fee with YES-secure or 1% with Zopa.

Giles Andrews, chief executive and co-founder of Zopa, believes that essentially people want to trust each other.

He says auction site eBay has helped set the precedent for sites like Zopa, which promote the idea that people can borrow from each other rather than from the banks.

"There's something anti-establishment about the site," Andrews says. "People say: 'I'm not going to buy from a big company any more.' The other side of it is the need for trust.

"Around 10 or so years ago, the idea that you'd post a cheque to a stranger on the basis that they would send something in return seemed crazy – but it worked."

Founder of YES-secure Dr Chandra Patni also describes his website as an "eBay-styled market". "We introduced the social-lending network as one of our key factors. People want to know who they're lending to and, as a result, you might even get offered better rates."

Online community

YES-secure subscribers can invite friends to join via Facebook and email. These are known as 'connections' and, in turn, you can let them know about good experiences you've had with specific lenders or advertise lending rates you're looking for with them.

Your 'reliability score', which comes from having lots of connections with good credit ratings, works alongside your own independent credit rating to give lenders a picture of you as a trustworthy borrower, and vice versa.

Forums play a big part on both sites, allowing members to share experiences. This social element is integral to the success of these sites – as it should be to the wider banking industry. 

So is this the end of traditional banking as we know it?

Andy Deek, managing consultant of financial services consultancy Navigant Consulting, believes the social lending platforms are too specialist to be a real threat to the main banks. "The banks view the likes of Tesco and Virgin as more of a threat," he says.

Andrews himself agrees that Zopa and YES-secure can't compete with the big boys, but he says that's because they are trying to target one specific area of the banking market.

"We're not about to start setting up current accounts for people, but for a certain type of banking activity, like unsecured personal lending, we do a better job than the banks," he says. "I can't see the banks ever being able to do this as well – or as competitively."

So maybe it's not a new way of banking, but it certainly is a new way of borrowing. 

Customer Service winner

Picking up first prize for best personal loan provider for customer service and most trusted personal loan provider at the Moneywise Customer Service Awards 2010, Zopa swept aside its more traditional competitors.

"I like the fact that I'm borrowing from people like myself," one customer says. Another adds: "I like the idea that I'm lending other customers money rather than investing it on the market."

It will be interesting to see if social-lending newcomer YES-secure will feature in next year's awards, or if Zopa continues on its winning streak.

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