All you need to know about peer-to-peer (P2P) lending

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 specialist platform

• Platforms can mitigate risk by splitting loans between multiple credit-checked borrowers and having provision funds, although these measures do not remove the risk of losing money

If you’re looking for potentially higher 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, without the need for a traditional intermediary such as a bank or building society.

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.

The platform will usually assess borrowers and carry out credit checks before putting them into a risk category. The borrower's risk level can affect the interest rate offered – generally, a higher perceived risk comes with a higher potential return for the lender.

Those lending can often have some choice over 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, which will credit check potential borrowers and then release the funds when they’re approved.

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

What should I consider before investing in P2P lending? 

Before investing in P2P lending, you should consider the risk of losing money, who you are lending to, how your money is protected and what fees you will pay.

Could my loan application be rejected or go unfunded?

Yes. Applying for a P2P loan does not guarantee that you will be accepted or that your loan will attract enough funding.

As with other forms of borrowing, the platform will assess your application and creditworthiness. If you do not meet its lending criteria, your application could be rejected.

Even if your application is accepted, there may be a risk that there are not enough investors willing to fund the loan. This means you may not receive the full amount you applied to borrow, or you may not receive the loan at all.

It’s therefore worth considering alternatives and making sure you can afford the repayments before applying.

Advantages and disadvantages of P2P lending 

There are positives and drawbacks for both lenders and borrowers when it comes to P2P lending:

Is my money safe with P2P lending?

There is always a chance of losing money with P2P lending if borrowers cannot repay their loans, and your investment is not protected in the same way as money held in a bank or building society.

Platforms may try to reduce the risk by splitting investments between multiple credit-checked borrowers and having provision funds to cover some shortfalls. However, these measures do not guarantee that you will get your money back.

Most P2P platforms are authorised by the Financial Conduct Authority (FCA) and must have the relevant permissions to operate a peer-to-peer lending platform. However, FCA authorisation does not mean your investment is guaranteed or that you are protected from losses.

Before investing, check the platform's FCA registration and permissions, and look into its track record and how it has dealt with previous problems or bad debts. You should also check independent reviews and feedback before committing your money.

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

You should also check that the platform is FCA-authorised and has the relevant permissions to provide P2P lending services. Remember that being authorised does not remove the investment risks.

How can I check if a P2P platform is a registered company?

You can check whether a P2P platform is a registered company using Companies House.

Search for the company's name to check details such as its company number, registered office and whether its status is listed as active. You should also check the FCA Register separately to make sure the platform has the appropriate authorisation and permissions to provide P2P lending services.

When is P2P lending a good option for a business?

P2P lending could be an option for a business that needs finance and has a clear plan for how the money will be used and repaid.

Before applying, make sure your business finances are in good order and that you can afford the repayments. P2P lending may be particularly useful when a business needs funding quickly for an opportunity such as expansion or purchasing equipment, but it should not be used as a way of covering ongoing financial problems without a clear repayment plan.

Compare the costs and terms with other forms of business finance before deciding whether P2P lending is right for you.

Have any P2P platforms failed before?

Yes. P2P platforms have failed in the past, showing that investors can lose money even when a platform has previously operated successfully.

For example, Lendy went into administration in 2019, while Funding Secure went into administration in 2021. Platform failure can make it harder for investors to access their money and can result in losses, particularly where borrowers also default on their loans.

This is why it is important to understand what would happen to your money if a platform collapsed before you invest.

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.

The right option will depend on whether you are investing or saving, how much risk you are prepared to take and when you might need access to your money.

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.