What is peer-to-peer lending?
Important information about peer-to-peer lending
Investing your savings in a peer-to-peer lending scheme can potentially result in better returns than more conventional forms of saving. However, it should only be considered as part of a balanced investment portfolio and is not for everyone. Peer-to-peer savings are not regulated by the Financial Conduct Authority and your capital will not be protected by the Financial Services Compensation Scheme should things go wrong. It’s important you understand both the advantages and disadvantages before making a decision on whether to invest, so please read this guide to help you make a more informed decision.
As the name suggests, peer-to-peer lending involves people using their savings to lend to other individuals, therefore cutting out the need for banks to be involved. The aim is that those who are willing to lend could get higher returns on their savings than they would if they put their money in a conventional savings account, and in turn the individuals they are lending to could get lower cost loans than they would if they borrowed through a bank.
Some peer-to-peer sites lend to small businesses too, which for many has proved invaluable in light of current tight bank lending restrictions.
As a lender, you can choose your rate of return based on the length of time you want to invest your money for and the level of risk you’re prepared to take. For example, if you only want to lend to those with the best credit scores you will earn less than if you are prepared to lend to a higher risk group.
There are charges and fees although these are usually already factored in to the rate you see advertised – this is worth checking though.
Anyone aged 18 or above who is a UK resident, has a UK current account and is not lending in the course of a business can usually become a peer to peer lender.
You don’t need to lend large sums to invest either, most peer-to-peer investments start from as little as £10 or £20.
What are the advantages of using peer-to-peer lending?
In today’s low interest rate environment, peer-to-peer saving is proving increasingly popular, returns can be considerably higher than those offered on most savings accounts, and are fixed for the period of the loan, which can usually be over either three or five years. In order to minimise the risks any money you lend can usually be split over multiple credit-checked borrowers in small chunks. Therefore if one person fails to keep up with their repayments, it doesn’t mean you would lose all your money.
Some peer-to-peer lending companies run their own schemes that guarantee to return every penny to investors through a Provision Fund which borrowers contribute to by way of a credit rate fee charged at between 0.5% and 3% of the loan.
For additional protection, most peer-to-peer schemes hold Consumer Credit Licences from the Office of Fair Trading and use the same processes and fraud prevention systems as banks, but always ask what protection is in place before becoming a lender.
Since April 2016, it has been possible to hold peer-to-peer loans within an Individual Savings Account (ISA), so that returns are tax-free. This type of ISA is known as an innovative finance ISA. This tax year (2016/ 2017), you can invest up to £15,240 in ISAs, either in stocks and shares, cash, or peer-to-peer loans, or you can invest in a combination of these.
What are the disadvantages of peer-to-peer lending?
Saving with peer-to-peer lending should only be considered as part of a balanced investment portfolio.
Peer-to-peer saving is not regulated by the Financial Conduct Authority and your money will not be covered by the Financial Services Compensation Scheme as with most standard investment schemes if the lending company goes bust.
Investing your savings within a peer-to-peer lending scheme is not for everyone. Interest rates vary significantly with higher returns gained through lending to higher risk borrowers. This in turn raises the risk that you may not get some or all of your money back.
If you need to withdraw your funds early, some schemes will charge a fee for doing this and some schemes don’t allow withdrawal of your capital early at all. It is sometimes possible to sell the loan on in order to get your money out early, but there is usually a fee for doing this and could take time, meaning you can’t access your cash in the interim.
If the person you have lent the money to within the scheme defaults on their loan repayments, there is a risk you could lose all or some of your money. Also, if the borrower chooses to repay their loan early, which many people do, it will have a knock on effect on your rate of return.
Compare options for investing in peer-to-peer lending
The number of peer-to-peer lending schemes available has increased dramatically in recent years, so comparing them and finding the right one to suit your needs isn’t always easy. However, you can use MoneySuperMarket to compare peer to peer investment options without having to trawl around all the different sites yourself.