The perpetually low interest environment has caused many savers to seek alternative ways of achieving better return on their cash and peer-to-peer (P2P) lending websites are an increasingly popular option.
P2P websites enable investors, or savers, to lend directly to borrowers thereby cutting out traditional lenders such as banks or building societies.
In this way, borrowers may benefit from lower loan rates than they’d get from a bank or building society and savers get better returns than they would on a standard savings account.
P2P lenders have been around since 2005 when the UK’s first lender, Zopa, launched; earlier this year it became the first lender to pass the £3bn threshold.
The growing number of P2P sites means that there is increasing choice for savers in terms of who they can lend to and the associated risk and reward; originally designed to provide an alternative source of personal loans, it is now possible to lend to small and medium-sized businesses or even property investors.
50% and 85% of applicants are turned down
Borrowers are credit checked when they apply for a loan and between 50% and 85% of applicants are turned down; it requires a high credit rating to be accepted and those with CCJs or that have been turned down by mainstream lenders need not apply.
In order to mitigate the risk of default, P2P sites split your investment across a number of loans and as a ‘lender’ you have some ability to influence the interest you receive; as an example, Zopa will split your investment between at least 200 borrowers.
If you are happy to risk lending to people with lower credit scores, you’ll be rewarded with a higher interest rate; if you want the security of only lending to people with perfect credit ratings, your return will be lower, but then so may your blood pressure be.
Becoming a P2P Lender
Would be P2P lenders need to establish an account with an online lender when they are able set the time horizon they are considering and what level of risk/return they are looking for.
As a rule of thumb P2P returns are very likely to beat those available on the high street (Wellesley currently has a 5 year fixed rate bond that pays 6%) and increased exposure to risk and a longer loan period – perhaps a five year fixed bond – will enhance the rates that can be achieved.
Wellesley currently has a 5 year fixed rate bond that pays 6%
Lenders are typically charged a 1% annual fee for using the service based upon the amount of interest they earn although this is likely to be tied up in the rates that are paid; those wishing an early exit from a fixed term loan may also be charged a fee.
Returns are unlikely to rival those possible from long term stock market investment but P2P lending can deliver a less volatile, although possibly less liquid, source of income.
Loans can start from just £10 and with the ability to take monthly interest payments, P2P lending may be of interest to those looking for a reliable source of income. There is no upper limit to the amount that can be saved.
Risks of P2P Lending
In April 2014 P2P lending was regulated by the Financial Conduct Authority (FCA) which gives savers a greater degree of protection; you can expect a more detailed explanation of how the process works as and made aware of all the risks involved.
The FCA included a number of minimum standards to which all P2P platform providers must operate.
These include minimum capital requirements for the company operating the platform, relative to the size of its loan book. This should give consumers more confidence that the platforms through which they lend and borrow today will still be around tomorrow.
Firms are also required to make contingency arrangements to ensure that loan books would be managed to maturity in the unlikely event of a platform failure.
Borrowers have also been given a mandatory 14-day ‘right to withdraw’ during which they can cancel their loan agreement without penalty; since April 2017 disgruntled P2P savers have had access to the Financial Ombudsman Service.
However, despite being regulated, P2P lending is not covered by the Financial Services Compensation Scheme (FSCS) which would protect the first £75,000 of your cash if it were held in a traditional bank or building society deposit account.
Another risk factor is that the advertised rate may not be the actual rate you will receive on your savings; this is determined by the risk profile of the individuals or businesses you decide to lend to, how long you want to tie up your money for and the prevailing rates at the time.
P2P operators mitigate this risk by dividing your loan between borrowers and some set aside a fund known as a ‘provision fund’ that savers collectively contribute towards that pays out in the event of a default; Zopa’s ‘Safeguard’ provision fund holds £8.9 million, just in case.
Since April 2016, P2P loand have qualified to be sheltered from the taxman in a new wrapper – the Innovative Finance ISA; despite a slow start due to difficulties in getting full regulation, there are now more than forty IFISAs to choose from, delivering a wide range of underlying investments such as property, green energy and SME loans, and different risk and reward characteristics.
A number of providers act as aggregators of other P2P companies’ loans, meaning that lenders get further diversification in terms of the borrowers they can reach; a comprehensive table of IFISA providers and their key features can be found here
The two main consumer peer-to-peer lenders are currently Zopa and RateSetter which target 4.6% and 5.6% respectively; Funding Circle specialises in loans to SMEs, targeting 7.2% and with Relendex you can contribute from just £500 into secure loans of £50,000 and above against commercial property investments with a target return of 8.65%
P2P lenders will also adjust the rate they aim to return to lenders according to the level of risk they are undertaking, as well as the duration of the loan; as an example Ratesetter offers a Rolling Market IFIA targeting 2.8% p.a., a 1 Year Market IFISA at 3.6% and a 5 year Market IFISA at 5.6%
P2P lending should be considered in the context of options such as ISAs, fixed rate bonds and high interest savings accounts; because of the large number of choices available it is worth spending some time getting to grips with the variations.
Muckle will begin by taking a closer look at a number of IFISA providers over the next few weeks.
In the meantime, we’d like to hear your experiences of P2P lending, and how it forms part of your journey to financial freedom – firstname.lastname@example.org