What Is Peer To Peer Lending?
Peer To Peer lending websites have grown in popularity over the past 10 years in the UK. They offer an alternative to both a traditional savings account and an investment fund. They are a hybrid of both in most cases. The basic idea is to bypass traditional banks, bringing together borrowers and lenders online. Borrows pay less than a traditional loan while lenders get a better rate of return. Sounds too good to be true? Lets find out below.
Interest rates on savings remain stubbornly low in the UK and while ISA's offer tax free savings, they are limited to £15,240. The result has been a rapid growth in the number of P2P lending websites operating in the UK and an increase in the number of people who are using them as an investment/savings vehicle.
The most popular P2P savings firms include Zopa, Funding Circle, Ratesetter and LendInvest and between them they have lent over £4.2bn - the market is huge. They promise returns of up to 7% which sounds very appealing when compared to traditional savings accounts.
Know The Risks - This Isn't For Everyone
It is important to remember however that these are not savings accounts and there isn't the same protection in place in the event of a disaster (the lender goes bust or the default rate on the loans increases dramatically). While savings accounts are covered by the Financial Services Compensation Scheme, P2P lending schemes are not.
There are however numerous safeguards in place. Borrows are credit checked and rated for risk. This determines the rate at which they can borrow and the returns on offer to you. Crucially, the P2P websites take responsibility for ensuring loans are repaid and many now have "Provisioning Funds" in place to cover losses incurred by bad debt.
Since April 2014, Peer To Peer lending is regulated by the Financial Conduct Authority to ensure only reputable companies offer these services. The new rules require P2P firms to present information clearly and be honest about the risks involved and the safety net they have in place. By April next year all firms will be required to have a "Provisioning Fund" in place. The size of this fund will be determined by the amount of money they have lent.
Another factor to bear in mind is that no interest will be paid on your money until it is lent out. A small amount should be lent quickly but a larger sum of money may take a few weeks to be fully invested.
If a P2P firm was to go out of business, the loan would remain in place between you and the borrower. The "contract" is between the individuals, not the P2P lender. All firms must have insurance in place which would pay for a debt collection agency to step in and ensure the loan continues to be repaid but in reality if a P2P firm went out of business, bad debts and losses would certainly follow.
The industry is still fairly new but we have not yet seen any major problems. No Peer To Peer firms have gone out of business and losses remain very small.
Which Peer-to-Peer Lender Should I Use?
Zopa - The Market Leader
- Active Lenders: 50,000
- Money Lent: £1.4bn
- Default Rate: 0.8%
- Average Return: 5%
- Who Pays Fees?: Borrowers - up to 2% depending on credit rating
- Min Investment: £10 - £500 recommended.
Zopa was established back in 2005 and its products now closely resemble a traditional savings account. You choose how much you want to invest, and for how long, and you get a fixed rate of return.
It offers 3 products offering projected returns (after bad debts) of 3.5% (Immediate access and no fee's for withdrawing money), 4.5% (1% fee for withdrawals) and 6.5% (higher risk, unprotected loans). If you need to withdraw your money it can take 3-5 days and can cost up to 1%.
Zopa's Provisioning Fund (called Safeguard) has £11.7m of funds to cover bad debts but the company focuses on minimising risk through credit checks and breaking investments into small chunks. A maximum of 2% of a lenders money is given to a single borrower.
RateSetter - Ideal For Beginners
- Active Lenders: 40,000
- Money Lent: £1.2bn
- Default Rate: 0.7%
- Average Returns: 4.6%
- Who Pays Fees?: Borrowers
- Minimum Investment: £10
RateSetter started in 2010 and most closely resembles a traditional savings account. You choose an account and put in the money you want to save/invest. Its now facing more direct competition from Zopa which makes it easier to compare the 2 offers.
RateSetter offers more flexibility than Zopa, with monthly, annual, 3 yr and 5 yr options available. You can also customise the rate you want to earn. A lower rate will be invested quicker while waiting for the right match could increase your returns. Money can be withdrawn immediately but your rate of interest will be reduced to reflect this.
Their Provision fund is the largest in the market with £17.8m available to cover bad debts.
Funding Circle - Business Lending
- Active Lenders: 47,000
- Money Lent: £1.4bn
- Default Rate: 1.5%
- Average Returns: 4.7% for 3 years, 6.2% for 5 years.
- Who Pays Fees?: Borrowers - between 2% and 5%
- Minimum Investment: £20
While Zopa and Ratesetter focus on lending to individuals, Funding Circle lends to businesses. As a result it offers the highest returns in the market along with a higher risk of bad debt.
Customers are offered 2 options: "Bespoke Lending", where lenders are given each loan proposal for assessment or "Spread The Risks," where the companies platforms spreads your investment over a range of lenders at a chosen interest rate. Money can be withdrawn in 1-3 days.
Funding Circle does not provide any Provisioning Fund to cover bad debts.
LendInvest - Investing In Property
- Active Lenders: 2,200
- Money Lent: £525m
- Default Rate: 0%
- Average Returns: 7.3%
- Who Pays Fees?: Borrowers, dependent on size of loan, credit rating etc
- Minimum Investment: £100
LendInvest is a 3 year old company that focusses on investing in property. Typical borrowers include professional landlords and developers who are looking for short term mortgages to buy or develop property in the UK.
The returns are very competitive but the main benefit of this type of P2P lending is the security offered. The loans are secured against the property which means losses should be very low.
The downside is that your funds are locked in for an average of 8 months for the duration of the loan so make sure you won't need the cash in the short term before investing.
Peer To Peer lending is here to stay and as it matures and develops the risk of the unknown should decrease further. Like all investments we suggest starting small, with a few thousand pounds of investment and increasing this over time as your comfort levels grow.