Peer-to-peer lending guide

Key takeaways

• Peer-to-peer (P2P) lending offers potential returns on investments, but it comes with risks

• With P2P lending, you lend directly to borrowers (individuals or small firms) through a specialized platform

• Platforms mitigate risk by splitting loans between multiple credit-checked borrowers and having provision funds

If you’re looking for bigger returns on your investments and you’re prepared to take on more risk, then peer-to-peer (P2P) lending could be worth a look.

But before you take the plunge it’s vital to understand the risks involved and research the P2P platform you’re considering using to find out how it works and what protections are in place.

What is P2P lending?

P2P lending is a way of investing where you lend directly to borrowers – usually individuals or small firms – through a specialist platform and eliminates the need for the intermediaries – the banks and building societies. 

So essentially you, the investor, become the bank, lending out money and receiving interest back on your loan until it is repaid in full. 

How does peer-to-peer lending work?

Platforms all work slightly differently, but the premise is that they bring lenders and borrowers together to arrange loans that benefit both sides.

Those lending can often have some choice on how long they want to lend out their money and what rate of return they expect to receive. Those borrowing can often get better terms than they might borrowing from a bank.

The money is invested through the peer-to-peer platform, who will credit check potential borrowers and then release the funds when they’re approved.

It’s worth noting that while peer-to-peer lending should be regulated in the UK, your money may not have as many protections as investments elsewhere.

What should I consider before investing in P2P lending? 

While P2P lending should be regulated in the UK, your money may not have as many protections as investments elsewhere. Here are a few considerations before investing in a P2P scheme: 

• Potential of getting your money back: Understand the risks involved and the potential for returns. 

• Understanding who you're lending to: It's essential to know the creditworthiness of the borrowers. 

• Ensuring that your money is protected: Check for provisions that protect lenders' funds. The considerations before investing in a P2P scheme also include what happens if the borrower goes bankrupt and is unable to repay their loan, as well as what happens if the peer-to-peer platform itself collapses. If the platform goes bust and administrators step in, the investment may be protected because the money is with the borrower who can still carry on paying the loan. Any funds on account and not currently on loan are usually kept in a separate bank account by the P2P platform. In some cases, investors may not receive all their money back in case of platform collapse, depending on how the account has been set up. 

• Platform fees: These could eat into your returns. These charges could include the cost of running the platform and a percentage of returns going towards the provision fund to cover bad debt. 

Advantages and disadvantages of P2P lending 

For Lenders 

Advantages: 

• Higher interest due to the elimination of banks and their fees 

• Flexibility in setting interest rates and timescales

• Confidence in the maturing market

• Tax-free investment if P2P loans are put within an ISA. P2P loans can be put within an Individual Savings Account (ISA) – known as an innovative finance ISA – so that returns are tax-free

Disadvantages: 

• Risk of losing investment if borrowers default on loans 

• Charges for managing P2P transactions 

• Lack of coverage by the FSCS. Financial Services Compensation Scheme protection is slightly more complicated. While the money on loan won’t be covered, any funds in a separate holding account may be protected by the FSCS provided it is held in a ring-fenced bank account independent of the peer-to-peer platform 

• Possibility of money being tied up with some schemes charging a fee for early withdrawal of funds 

For Borrowers 

Advantages: 

• Competitive rates 

• Accessibility 

• Fast and simple application processes. For borrowers, P2P lending platforms use innovative technology to make application processes simple and provide quick decisions on whether you’ve secured a loan deal 

• 'Soft' credit checks. Many P2P lending platforms use soft credit checks when you make an initial enquiry, which will show you your chances of being granted a loan, but won’t affect your credit score 

• Multiple options due to the popularity of P2P lending 

Disadvantages: 

• Less flexibility in restructuring debt 

• Information passed on to collection agencies more quickly in case of missed payments 

• The temptation to borrow more than needed. For borrowers, P2P loans may tempt you into borrowing more than you need, making it more difficult and expensive to pay off 

• A peer-to-peer loan might also be secured against collateral such as a house, which can be sold to pay lenders in extreme cases 

Is my money safe with P2P lending?

While many P2P companies have a successful track record, there's always a chance of losing money if borrowers can't repay their loans. However, platforms often mitigate this risk by splitting investment loans between multiple credit-checked borrowers and having provision funds to cover shortfalls. Most P2P schemes hold Consumer Credit Licences with the FCA and use the same processes and fraud prevention systems as banks. 

Choosing a P2P Lending Platform 

Factors that make a good P2P lending platform include: 

• Offering a good rate of return on investment 

• Providing flexible options for lending

• Having a robust structure and reserve funds to cope with bad debtors 

• Being straightforward and easy to use

• Having a solid history of past performance

Alternatives to P2P Lending 

Alternatives to P2P lending could be stocks and shares ISAs, and different savings accounts like easy access, regular saver, notice accounts, fixed rate bonds, and cash ISAs. 

P2P Lending vs. Crowdfunding 

P2P lending involves an investor’s money being used as a loan that a borrower agrees to repay with interest. In contrast, crowdfunding is led by an individual or company looking to raise funds for a project, with investors buying chunks of the business or expecting a return plus interest in the future. 

Compare peer-to-peer lending with MoneySuperMarket

The decision to invest in a P2P lending scheme depends on personal choice, attitude to risk, and whether potential returns outweigh the risk. It is advisable to do your research before investing and consider spreading your investments as part of a balanced investment portfolio. You can quickly view peer-to-peer lending options on MoneySuperMarket which provides a comparison of potential investment platforms with information about interest returns, platform charges, and how your money will be protected. 

Overall, P2P lending can be a potentially rewarding investment option if you're willing to take on more risk. However, it's crucial to understand the workings of the P2P platform and the risks involved before investing in it. Always remember, the key to making sound financial decisions lies in doing your homework and understanding your risk tolerance.