Marketplace lending is a modern approach to providing loans to small businesses and individuals. It uses an online platform to connect borrowers with investors, and instead of charging interest, MPLs generate revenue through a small fee for payments processed on the platform.
In this article, we explore the basics of marketplace lending and its potential benefits and risks. We also provide the step-by-step process of developing and improving a lending platform. Read on to get some tips on creating a successful marketplace lending platform.
Marketplace lending explained
Marketplace lending is a form of alternative lending that bypasses traditional financial intermediaries like banks and credit unions and connects borrowers with potential lenders through an online platform. It usually incorporates all of the following attributes:
- loans are provided to individuals and small businesses;
- online lending marketplace doesn’t have physical locations;
- almost the entire loan lifecycle is automated;
- marketplace lenders are funded by issuing equity or selling loans to investors;
- loans are usually unsecured, small, and short-term.
The sector of marketplace lending is growing rapidly. According to statistics, its global transaction value is expected to reach $34.7 billion within the next four years.
Originally a peer-to-peer lending concept, marketplace lending has evolved to include institutional investors interested in funding this activity. As more commercial lending marketplaces are being launched, traditional financial institutions are also beginning to adopt this innovation to keep up with the competition.
How does marketplace lending work?
Lending marketplaces do not directly lend or approve loans. Rather, they connect borrowers with direct lenders, who are typically private or institutional investors. Depending on the regulations of a specific region, direct lenders may be required to obtain a license. Lending marketplace involves the following steps:
- A borrower submits an online loan application, which is assessed using the marketplace lending company’s credit scoring tool.
- The lender’s algorithm assigns a credit grade to the loan request based on factors such as the borrower’s credit score and income.
- Once assigned, the loan request is advertised for investors to review and pledge funds based on their investment criteria.
- The marketplace issues security notes for investors in exchange for the investments used to fund the loan.
- After the process is complete, the borrower must make monthly payments to the marketplace. The marketplace will then pay the investor a proportionate amount after deducting the loan servicing fees.
Some marketplace lending companies partner with banks. In this case, the process differs:
- The marketplace lending company affiliated with a bank handles borrower applications, assesses creditworthiness, and collects investor interest.
- The marketplace sends completed loan applications to the partner bank, which makes the loan to the borrower.
- The bank issues the loan and sells it to the marketplace.
- The marketplace issues security notes up to the purchase amount and offers them to its retail investors to pledge to fund the loan.
- After the process is complete, the borrower must make monthly payments to the marketplace. The marketplace will then pay the investor a proportionate amount after deducting the loan servicing fees.
Using these two approaches, marketplaces can offer borrowers unsecured consumer loans, debt consolidation loans, auto loans, purchase financing, education financing, real estate lending, merchant cash advance, medical patient financing, and small business loans, using these two options.
The advantages of marketplace lending
Marketplace lending model offers plenty of benefits to both borrowers and investors alike.
Benefits for borrowers:
- alternative credit options for those who struggle to obtain loans from traditional banks;
- simplified loan applications and quicker loan disbursement;
- competitive rates, particularly for borrowers with good credit scores.
Benefits for investors:
- lending to multiple borrowers with different risk profiles helps investors diversify their investments;
- higher returns compared to traditional investments like savings accounts or bonds;
- direct participation in the lending process without intermediaries, which lowers fees and enables greater control over investment decisions;
- more informed investment choices by considering the risk and return characteristics of various loans;
- access to new markets.
What is the potential of building a lending marketplace?
Compared to traditional lending, marketplace lending offers lower cost structures, more accurate underwriting, and faster, more convenient application and underwriting processes. Advocates believe these advantages will transform how people and small businesses acquire credit and lead to better financial and societal outcomes, such as:
- lower rates for borrowers,
- increased availability of credit, especially for underserved market segments,
- higher returns for credit investors.
The demand for marketplace lending is driven by various factors, including the growth of small and medium-sized enterprises, especially in emerging countries; lower operating costs and market risk for both lenders and borrowers; and the utilization of advanced technologies for risk assessment.
Given the potential beneficial outcomes and the factors fueling the interest in marketplace lending, experts predict the sector will continue to gain popularity.
Potential risks
Just like other financial sectors, marketplace lending comes with risks and uncertainties. Some observers have highlighted the following concerns:
- The accuracy of underwriting and loan performance has not been tested during an economic recession.
- Marketplace lenders’ ability to attract borrowers and raise funds in various economic conditions is uncertain, given the high demand for loans and funding seen during economic expansions with low interest rates.
- Without proper oversight, marketplace lenders may engage in unsafe or unfair lending practices. This could create complicated conditions for other lending organizations.
In addition to standard practices, effective risk management in marketplace lending involves staying current with lending industry trends, conducting thorough due diligence, and being flexible in the face of changes.
How to build marketplace lending in 7 steps
If you’ve made it this far, you’re probably seriously committed to starting your own marketplace lending platform. To help you out, we’ve put together a step-by-step guide that will show you how to develop marketplace lending in the most resource-efficient way possible. Let’s get started!
Step 1: Validate the problem
The worst-case scenario for any product is investing a significant amount of time and money in development, only to discover that there is no demand for it. To avoid this, start with problem validation. Here’s how:
- Write down your goals, assumptions, and hypotheses to examine and test them. This can save you time by clarifying the value of your product, what sets you apart in a crowded market, and what you understand about your business model.
- Assess the size and potential of your market through research.
- Research the search volume of related terms to determine if there is demand for your product or service.
Problem validation is an ongoing process. Continuously revisit it as you develop your lending platform. Insights gained from it guide the further product development and increase chances of success.
Step 2: Define your target audience
Understanding your audience is key to success. Research and analyze their needs, pain points, and preferences to create a strong product strategy and effective marketing campaigns.
- Identify your potential customers: Will you build a P2P lending marketplace for individuals, a business lending marketplace for small businesses, or a solution that serves both categories? Determine why they need your platform and what tasks they will perform with it. Who will provide funding?
- Conduct customer validation interviews to gather feedback on their needs, problems, and ideal solutions.
Step 3: Analyze competitors
Analyze marketplace lending platforms to identify their strengths, weaknesses, and areas where they fail to meet customer needs. This will give you actionable insights into your product’s positioning.
Step 4: Product planning
Once you have validated the problem, formed a clear vision of your target customers, and analyzed competitors, it’s time to move on to product planning (or the discovery phase). The purpose of this step is to identify the project’s vision, goals, and scope and set the stage for further lending marketplace platform development. Therefore, the quality of the outcomes is crucial for the product’s success. During this stage, the following should be done:
- Requirements analysis
- Monetization model selection
- Choice of architecture
- Defining tech stack and integrations
- Feature selection & prioritization
- Documenting software specifications
While it’s possible to do it on your own, we recommend approaching a software development company that offers discovery as a service. This way, you can rest assured that your project is fully prepared for a proper start.
Note that if you are going to partner with a bank, this stage will also include selecting potential partner banks and negotiating collaboration terms.
Lending marketplace key features
We recommend that you carefully consider the list of features. The starter feature set includes:
- User accounts, profiles, and settings
- Search and filters
- Loan calculator
- Payment system integration
- ISA/IFISA support
- Auto payments
- Notifications
- User support
- Review and rating (for both lenders and borrowers)
- Secondary loans market
- Admin dashboard with visualized analytics and reports
- Automated onboarding & KYC/KYB verification
These features are sufficient for launching the first version of your platform. Introducing too many features from the very beginning can have two negative consequences. Firstly, it can increase the timeframe and cost of lending marketplace development. Secondly, it can result in redundant functionality that frustrates users and pushes them away from your platform. Instead, it is advisable to focus on essential features sufficient for users to complete their tasks and introduce new ones as the need arises.
Step 5: Prototype and design
Create a basic prototype of a platform that is sufficient to test your core value proposition. Share it with a smaller group of potential users and gather feedback on its usefulness and usability.
After making adjustments based on the feedback, you can begin creating the full-fledged design of the future platform. Pay attention to creating a simple onboarding flow that will guide users through the platform, as well as clear navigation that will allow them to easily find the information or features they need.
Step 6: Develop and test the platform
Here you have two options: building a marketplace lending platform from scratch or using a white-label lending marketplace solution.
- Creating your platform from the ground up provides you with complete authority over the features, design, and structure. This is a great alternative if you have specific needs or want full ownership of your codebase. Nonetheless, starting from scratch can be a time-consuming and resource-intensive process.
- Using white-label marketplace platform frameworks or content management systems can speed up development. Existing solutions offer ready-made components and features specifically designed for marketplace platforms. Although this approach can save time and effort, you may have less flexibility to customize certain aspects.
Step 7: test and deploy
The next step involves developing and deploying the platform itself and integrating it with selected third-party services. It also includes a combination of unit tests, automated service and UI level tests, and manual testing. Unit tests are conducted to ensure that individual components or modules of the platform are functioning as intended. On the other hand, automated tests are designed to simulate user interactions and detect potential issues that may occur in various scenarios. Manual testing involves real users evaluating the platform’s usability, performance, and functionality.
Now, your marketplace lending platform is all set to onboard customers.
Post-development improvement and scaling
After lending marketplace development, the journey is far from over. Now it’s time to focus on improving and scaling the platform. This includes monitoring user engagement and feedback, analyzing platform data, and regularly updating and introducing new features.
User engagement, conversion rates, and user feedback monitoring
These are essential metrics to track. Based on the change of indications, you can make data-driven decisions and introduce products and offerings that are tailored to your users’ needs. User feedback is an excellent source of actionable insights that you can use to inform decisions about future updates and enhancements.
Platform data analysis to identify areas for improvement and optimization
Data that can be used includes borrower information (credit scores, loan applications, employment history), investor data (investment history, preferences), loan performance data (repayment history, defaults), platform usage data (user interactions, click-through rates), and more. Analyzing this information comprehensively will allow you to identify bottlenecks, inefficiencies, and areas for improvement.
Regular updates and new features
Regularly updating your marketplace lending platform allows for improved security, bug fixes, enhanced performance, compatibility, and avoidance of technical debt. Moreover, as time goes by, it will be necessary to add new features. This is the standard approach for all products seeking to provide even greater value to users, expand into new markets, and continue to grow their user base.
Summary
The marketplace lending industry is a promising financial services sector that continues to attract a growing number of borrowers, lenders, investors, and banks. If you are considering starting a marketplace lending business, there are two options:
- creating from scratch in-house or by outsourcing a dedicated team,
- or using a white-label marketplace lending software.
Whether you have a specific idea in mind or need help developing one, Itexus can assist you. Since 2013, we have been partnering with businesses across various sectors worldwide to help them achieve their goals using technology. Our team of talented professionals is ready to contribute their deep understanding of the financial services industry and strong technical skills to your project. Contact us to discuss your goals and expectations, and discover what we can do for you.