financial planning

Saving with peer-to-peer lending sites

Life has been pretty tough for savers in recent years, so it’s hardly surprising that many people are looking at alternative ways to boost the amount of interest they earn.

Peer-to-peer lending websites, that enable savers to lend money to individuals and small businesses needing loans for example, are one option.

The idea is that savers earn higher rates of interest than they could get from a standard savings account as they are cutting out the costs of the ‘middle man’ – namely a bank or building society. And, as for borrowers, they can often find cheaper loans than if they went to a mainstream 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.

If you invest outside an ISA, you can now earn up to £1,000 a year tax-free interest if you’re a basic rate taxpayer, or £500 if you’re a higher rate taxpayer.

For savers

The first thing to note when investing in a peer-to-peer lending website, is that your money won’t be protected by the Financial Services Compensation Scheme (FSCS), which covers up to £75,000 (as of January 2016) of your money in the event that a bank or building society goes bust. We’ll explain more about this later.

You’ll then need to establish how much money you want to lend and over how long. Borrowers will pay you back over this period, with interest on top. You can usually start lending with as little as £10, although the more you are prepared to invest and the longer the term, the higher your potential returns will be.

Usually your money will be lent across several borrowers to help reduce the level of risk. In other words, if one of them struggles to make repayments, it won’t have such an impact as if you’d lent to them alone.

Most peer-to-peer lenders offer their own protection schemes too (often called ‘provision funds’) which will compensate you in the event that borrowers default on their payments. As a saver, you won’t have to contribute to this fund. Instead, borrowers usually pay a credit rate fee towards the scheme.

But, as previously mentioned, provision funds are NOT the same as the £75,000 (as of January 2016) worth of protection you would be offered at any mainstream savings provider via the FSCS.

Peer-to-peer lending sites also minimise risk for savers by vetting borrowers very thoroughly. Some sites turn down the majority of applicants – and anyone with a poor credit rating or who has defaulted on loans in the past will definitely not be accepted.

...savers earn higher rates of interest than they could get from a standard savings account as they are cutting out the costs of the ‘middle man’ – namely a bank or building society.

What sort of returns can I expect?

As a rule, the returns advertised by peer-to-peer lending websites are much higher than those offered by bank and building society saving accounts. However, to get the very best rates, you will have to commit to lending your money for the longest time – up to five years in fact.

Just as with a fixed rate bond, you will have to lock your money away for whatever term you choose, so think carefully about the duration before you sign up.

If you need to access your money before the term ends, most schemes enable you to sell on your loan. But, as it will need to be on exactly the same terms and within the same timeframe, the process can take a while. There will usually be charges involved too so it’s best avoided if possible.

Even if you stay within your agreed term, peer-to-peer lending comes with standard charges for savers – it’s how the sites make their money. But these are usually a slice of the percentage rate you earn and factored into the advertised rate. In other words, as a saver, the rate you see is the rate you get.

Peer-to-peer sites – are you protected?

Peer-to-peer lending websites have been regulated by the Financial Conduct Authority (FCA) since April 1, 2014. This means all sites now have a duty to ensure consumers are fully informed about how peer-to-peer lending works before they commit their cash.

As we have mentioned, FCA regulation still doesn’t mean your savings are covered by the FSCS. But peer-to-peer lending sites do have their own provision funds in place which are designed to pay out in the event that one or more borrowers can’t meet repayments

Always read the small print carefully so you know the level of safeguard that’s offered and whether the fund is held by an independent third party.

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