The term ‘skin in the game’ is often used in peer-to-peer(P2P) lending. You may have come across this term and wondered what it means. Skin in the game refers to the financial stake one has towards a project or investment. This might not always be financial, but can also refer to personal time or reputation in a project.
In this article, we’ll focus more on the financial aspect of having skin in the game and how it works in peer-to-peer lending.
How Does ‘Skin in the Game’ Work in P2P Lending?
In peer-to-peer (P2P) lending, borrowers get loans directly from investors. Loan originators are the companies that set up and manage these loans. Loan originators need to have ‘skin in the game’, which is when they invest a certain amount of their own money in the loans they give out.
For instance, if a loan originator has 10% skin in the game, they are risking 10% of the loan themselves. This shows that the loan originator is confident in the borrower. It also encourages and assures investors that a thorough process was followed to carefully check borrowers before lending.
What Are the Different P2P Lending Models?
Peer-to-peer lending is when lending happens directly through the use of online services. This form of lending exists as a cheaper alternative to traditional models. P2P lending has two models. Which are:
1. The three-party business model consisting of lenders, a P2P platform and borrowers
In the three-party model, lending happens directly between investors and borrowers through a P2P platform. The platform is a middleman. It connects people who want to lend with people who need loans. The platform handles the matching, payment and monitoring of repayments. Investors lend the full amount, and borrowers repay the loan with interest over time. The platform earns fees for its services. In this model, there is no loan originator.
The platform verifies the borrowers and reduces the risk. Investors rely on the platform to ensure the borrowers are trustworthy. This model works for small loans and simple arrangements. It’s cheaper because there’s one less party in the process. Investors need to review the borrower information carefully since the platform’s role is limited to facilitation and monitoring.
2. The four-party business model consisting of lenders, loan originators, a P2P platform and borrowers
The four-party model adds a loan originator between investors and borrowers. Loan originators are companies that create and manage loans. They assess borrowers, set loan terms and manage repayments. Investors can fund part or all of a loan created by the originator. The P2P platform connects investors and borrowers and provides support services.
A key feature of this model is that loan originators have skin in the game. They invest a portion of their own money in each loan. The four-party model is good for larger or more complex loans. It allows investors to benefit from the originator’s expertise and experience. Borrowers get professional loan management and checks. The model builds trust as the originator has a financial stake in the loan being repaid.
What is the Importance of Skin in the Game for Investors
Skin in the game is not just a phrase. It shows that the loan originator is confident in the borrower. When a loan originator invests their own money in a loan, it indicates that they have carefully checked the borrower’s ability to pay back. Investors can trust that the originator has a real interest in the loan succeeding.
Having a financial stake also makes the originator act responsibly. They only benefit if the borrower repays the loan. This encourages careful checks and regular monitoring of repayments. It reduces the risk for investors, especially in cases where borrower information is limited or unclear.
Skin in the game can also increase returns. Loans with originators who invest their own money usually fail less often. They also recover better if problems come up. For South African small business owners and individual investors using P2P lending, understanding this concept is key. It helps them make smarter decisions and pick originators who share responsibility.
The term ‘skin in the game’ is often used in peer-to-peer(P2P) lending. You may have come across this term and wondered what it means. Skin in the game refers to Read More
