Mike Lobanov, partner at Target Global discusses the power of peer to peer lending for disrupting the mortgage industry.
Fintech has become the dominant industry for any start-up looking to make a significant disruption. In recent years there have been huge inroads made in changing the way people make payments, send remittances and use most retail banking services. At the same time the world of crowdfunding and peer to peer (P2P) lending has helped redefine how companies raise money and how consumers take out loans. Thanks to this groundwork the next industry which is being targeted by P2P services is that of consumer mortgages, part of a growing interest in ‘PropTech’, or property tech.
Although in its infancy in the United Kingdom the process of changing how people take mortgages is already firmly underway in the United States, where the current process of taking out a mortgage is deeply flawed. Not only is it long and inefficient but it still requires an unwieldy amount of paperwork. However, what is very interesting is the impact of the Dodd-Frank Act, introduced in America as a reaction to the crisis in 2008 which led to America's two largest mortgage firms Fannie Mae and Freddie Mac almost going bankrupt.
The Dodd-Frank Act now places a lot of boundaries on banks when they provide mortgages, boundaries which have been decided on by reflecting on the exact developments of the past. In drafting the legislation policy makers started from the position of ‘why did the crisis happen?’ From this point of view, the legislators decided that limiting the lending activity of banks to those who seemed like bad creditors was the most appropriate course of action.
One issue I identify with this reflective method of policy-making is that it can sometimes cause quite absurd rulings. For example, now in the United States it's very hard for a consumer to get a mortgage if they have changed their jobs in the last two years even if their income has substantially increased. An unintended consequence of the legislation is that Dodd-Frank has created a one-size-fits-all template, and failure to meet this template will result in an inability to secure a mortgage. Naturally this puts in place the perfect conditions for a fintech player to disrupt the service by selecting the best borrowers and providing them loans. As a P2P lender, if you can appropriately profile a borrower who has had a significant income increase, then they would gain dividends from what should be as a good loan.
Another issue as a result of Dodd-Frank is that realtors themselves under-perform because a large number of clients are unable to secure financing. This encourages realtors to direct potential customers towards any new service which, even if it charges a higher rate, is able to fund their real estate purchase. Consumers can then purchase their property and wait until they are eligible to refinance their loan from their bank at a lower rate. This can actually create a really interesting future for the marketplace. Compared to direct loans, where peer to peer platforms help consumers refinance credit card debt at lower interest rates, the reverse could take place in the mortgage market. There is significant scope for large growth in banks offering refinancing terms from alternative lenders and attracting borrowers from P2P platforms when they are eligible for the lower rate of finance from a bank.
Naturally, all new systems and processes are never 100% positive and the industry would have to counteract best practices and regulations. Mortgage loans are usually related to primary homes and defaults are a very painful experience. Banks already have established eviction practices and regulation is in place to guard the process. Governments need to be very concerned about the eviction practices of lenders. Eviction practices do differ from state to state and in the United Kingdom government would have to address regional discrepancies as well. When implementing an appropriate regulatory framework for anyone wanting to start a lending business, regulators should really begin by creating a high barrier for entry while the industry establishes itself. As a result, if a lender is able to overcome this hurdle then they should have no boundaries towards their growth. The demand for financing home purchases will always be massive and the main thing to concern themselves about is the execution of attracting lenders to provide capital and the borrowers will naturally follow on to the platform. Certainly if capital is able to be deployed at an attractive interest rate and secured against the property asset, there will be sufficient supply and demand. Prosper and LendingClub demonstrated that in P2P consumer loans. Mortgage and real estate loans should follow that path as well.
Without a doubt 10 years from now P2P lenders could replace banks and offline providers for most straightforward and standardised financial products. Mortgages are a great example of this because they are a relatively straightforward product. Once lenders have a method to assess the credit risk of an individual they can draw on firms such as Lendinvest, Assetz Capital and Landbay to underpin this with knowledge of the quality of the underlying asset.
Where money is the commodity, whoever offers a borrower a cheaper and smoother process via their platform will come to dominate the market. Compared to a bank issued mortgage, which requires large amounts of paperwork and bureaucracy, P2P lenders may be much more fast and efficient, which should make borrowers flock towards them. The only remaining issue to resolve is regulation. Once in place, there will be no boundaries on P2P lenders to conquer the mortgage market.