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Q: Liking the idea of peer-to-peer lending, a few months ago I started to invest a bit of money in Harmoney.
In recent weeks I have been paying more attention to the amounts being borrowed, percentage of income required to make payments, and the purposes for the borrowing.
It would honestly make a financial adviser cry. It is almost starting to seem immoral if not extortionate to be lending to these people.
Examples that I have seen this morning:
• $5000 at 40 per cent for a holiday.
• Monthly repayments of $900 on an income of $3400 (over 25 per cent of income). These people also have a mortgage to meet.
• Lending at 14 per cent to homeowners who should realistically be able to borrow against their mortgages at 6 per cent.
• Rewrites of loans (for debt consolidation) after only four to five months from $20,000 to $25,000.
While it seems cute to say people can work out the costs, how many of these borrowers can or do? Is the guy borrowing $5,000 for a holiday really aware that it will probably cost him much closer to $10,000?
It seems to me that Harmoney has become (maybe it always was) an irresponsible lender. It appears to have become everything I hate about a payday lender, or a mobile shop offering finance.
Maybe this is the nature of the space Harmoney inhabits. And it is my job as an investor to steer clear of investments that I see as unethical.
PS: This is not about the risk to me as an investor, but more the ethics of lending to people who don't look like they can afford it.
A: The main issue here, it seems to me, is that every borrower has their eyes wide open.
For the benefit of others, peer-to-peer lenders operate through websites, bringing together people who want to borrow money with people who want to lend, and charging each side a fee. The Commerce Commission confirmed recently that it is looking into peer-to-peer lenders' fees and expects to report on them early next year - but that's another topic.
Through Harmoney, lenders typically spread their money over several borrowers.
Neil Roberts, CEO of Harmoney, says the examples you've given are at the risky end of their borrowers. Each borrower is assigned one of 30 risk grades. Interest rates range from 9.99 per cent on A1 loans to 39.95 per cent on F5.
I agree with you that close to 40 per cent is a horribly high rate, although Roberts says F5 loans make up less than 0.5 per cent of Harmoney's total loan portfolio.
Asked about your concern that borrowers won't realise how much a loan will really cost them, Roberts says, "Put simply the process starts with a calculator that requests the amount and provides repayment information, and ends with a breakdown of the loan amount, repayments, interest charges, interest rate and fees, delivered on screen and by email.
"So this concern would be better pointed toward those that operate in the offline space, where it may be possible to get through a process without knowing this information. "
When the Responsible Lending Code was introduced in June, "Harmoney already met or surpassed the standard in all material respects," he says. "Harmoney also complies with 11 different sets of legislation, and in addition Harmoney operates under a Peer to Peer Lending License issued and regulated by the Financial Markets Authority."
Harmoney was the first peer-to-peer lender to be licensed by the FMA. It has since been joined by Lendme, Squirrel Money and Lending Crowd.
Roberts says Harmoney satisfies itself that a borrower will be able to repay the loan. In the process, it turns down the majority of applications. "In the first year of business, Harmoney has received $1 billion of applications and written $100 million of loans.
"Our average borrower is 45, married or de facto, owns their own home paying off a mortgage, earns considerably more than the national average and works in the trades, junior management or emergency services."
He adds, "With respect, we would strongly suggest your writer not invest, and we will consider the market as having operated the way it should i.e. provided the depth of information for an informed decision.
My opinion: Your list does make rather alarming reading. I would have hoped that the holidaymaker, in particular, would have looked at the numbers and realised that if he or she postponed the holiday and saved up for it, the money would go a lot further.
But according to Roberts, borrowers know what they're getting into. And nobody's forcing them.
The people on your list who could instead have added to their mortgages or taken out bank loans were free to try that. We can only assume they chose not to or were turned down and then moved on to Harmoney, and that they felt they needed - I hope it wasn't merely wanted - the money, even though they're paying a pretty high price for it. Their choice.
Before peer-to-peer lending, some desperate borrowers - hopefully not holidaymakers - had nowhere to go but payday lenders. And interest rates there can be way above 40 per cent. I prefer having regulated peer-to-peer lenders filling the gap between banks and - let's face it - loan sharks.
However, there may be more reason to worry about lenders to Harmoney. See Diana Clements' article on the next page.
Q: I do chuckle when the misuse of "freehold" for "mortgage-free" arises, and when it's in one of your columns I imagine the grimace you likely make. At least no one has come out with a definition that freehold means you hold it for free - let's hope we never go there.
A: Indeed.
Q: We have just received a $75,000 windfall and are wondering how to invest it. Should we pay more off our home mortgage and reduce the interest, or perhaps look at an affordable rental property in an area like Rotorua, and hope to profit with capital gain?
We are both in our late 30s, with a mortgage of $279,000. After long periods overseas and being self-employed, neither of us has KiwiSaver.
A: Your two options are a long way apart on the risk scale.
While buying a rental property somewhere like Rotorua is a lot safer than buying in the overheated Auckland market, there are still risks and hassles with any rental.
They've been listed here before: tenants who don't pay or wreck the place, a lack of tenants, unexpected high maintenance costs, and so on. And it's always possible to lose money - or make less than in a bank term deposit - because the neighbourhood deteriorates, the home turns out to be leaky, or the place is contaminated with P.
Ask yourselves: If the rent doesn't cover mortgage payments, can you easily make up the difference - even if your income plummets?
And are you prepared to travel to Rotorua quite often, or pay for property management, which will eat into your profit?
Meanwhile, your other option, paying down the home mortgage, is risk-free. And it's the equivalent of an investment that earns a return, after fees and taxes, equal to your mortgage interest rate.
Sure, a rental property might return more than that, but only "might". I say get rid of your mortgage first. Then you're in a strong position to take on a fairly risky investment like rental property.
By the way, I can't resist suggesting you get into KiwiSaver, and each contribute $1043 a year - perhaps by transferring $87 a month from a bank account.
At that contribution level, the government will contribute $521 a year - multiplying your savings by 1.5 each year. That means your retirement funds will be 1.5 times as big - for example, $150,000 instead of $100,000 if you had saved the annual $1043 elsewhere.
Q: (From Rod Severn, CEO of the Professional Advisers Association (PAA)) Contrary to the assessment in the Melville Jessup Weaver report discussed in your column recently, it is not common practice for insurance advisers to switch clients simply to earn more upfront commission.
Replacement business occurs for a number of reasons: the client needs change; new products with better benefits are introduced etc. All reasons for change are lumped together and called replacement business. The MJW Report did not accurately assess replacement business, which then drove an unbalanced focus on commissions and adviser practice.
Replacement business processes do need to be further tightened across the entire insurance industry, which the PAA is addressing as part of the Financial Advisers Act review. However, we would like to be clear that the vast majority of advisers recommend that their client's change insurer only when there is a material benefit for the client in doing so.
As for commissions, while advisers are remunerated upfront, they continue to support their clients long after (often many years) the policy is initially put in place - at review time or at claim time etc - at considerable cost to their business. Unfortunately, the upfront and ongoing cost of providing advice was also not explored in the MJW Report.
Advice is hugely valuable. I am very concerned that commentary regarding upfront commissions in isolation will do significant damage in undermining the public's perception of the value of advice.
A: Thanks for your perspective. You're not the only one writing along these lines. Some points made in letters from insurance advisers:
• "What people are missing in the MJW report is the massive disservice it does to the public. If we abolished independent advisers, and the suggested actions would potentially cause this, we'd end up with poor quality bank peddled products that are sold en masse and not advised on.
"This would ensure financial support at critical times in people's lives is less than it needs to be. Access to medical treatment and supporting incomes in disability are the key issues for people today, with 75-80 per cent of people currently exposed in this area. Life insurance in the form of life cover is a long way down the list."
• "I'm fiercely independent, yes even though I get paid on commission, about being able to provide the right solutions to my clients. To this effect I hold agency agreements and can access all providers in the industry, excepting for the tied ones like Westpac and BNZ etc.
"I'm paid pretty much the same by all of them, the commission bias perceived isn't actually there. In most cases the products I recommend usually come at a lower commission rate than others I do have access to."
• "As for bank insurance having less churn, well they can't offer a better or alternative product as they only have one to sell. Most bank life products other than straight life cover are very poorly rated and don't come close to what is offered in adviserland.
"It is common to have only nine conditions covered as part of a bank trauma policy when, for the same money, an independent adviser can recommend a product that covers in excess of 40. Which one would you prefer?"
Okay, both sides have had their say now. Let's hope we can come up with a system that works for both advisers and consumers.
'Debt becomes more like a rent payment that people get so used to paying.'