What is peer-to-peer lending?
As a peer-to-peer investor, you will lend your money out to individuals or businesses. You will have a say about what interest rate you want to earn (within boundaries).
For example, if you are happy to take the risk of lending to people with lower credit scores, you’ll get a higher interest rate. And if you want the security of lending to people with excellent credit ratings, who are very unlikely to miss a payment, you’ll get a lower interest rate.
Peer-to-peer loan companies reduce the risk by spreading your investment over many borrowers, meaning that your rate of return should only be slightly affected should one of the borrowers default on his or her loan.
If you lend £2,000 through Zopa, for example, the sum will be split between at least 200 borrowers. It is for this service and the sourcing of borrowers in the first place, that you will charged a fee. The fees are usually factored into the interest rate you are offered, but always check so you know exactly what you are getting into.
How can you invest via a peer-to-peer lender?
To become a peer-to-peer investor, you will first need to set up an account. This means supplying some personal information such as your name and address, choosing how long you want to tie your money up for (and in some cases, at what rate) and, finally, making an online transfer of the cash you want to invest.
What are the benefits?
For most investors, the big draw of peer-to-peer lending is the fact that returns are highly likely to beat those available on the high street. As already mentioned, you can boost these returns even further by lending to higher-risk borrowers – and for tying your money up over the longer term.
While better returns may still be available via the stock market, peer-to-peer lending also offers a less volatile – albeit a less liquid – income stream.
Many peer-to-peer lenders also allow you to invest as little as £10 or £20, while investors with larger amounts will benefit from the fact there is generally no upper limit on how much you can lend.
Investors can also opt to receive interest monthly, meaning that you can choose to reinvest this cash or keep it for other purposes.
Are there any risks?
Yes. Firstly, even though the peer-to-peer sector is regulated by the Financial Conduct Authority, your cash will not be protected under the Financial Services Compensation Scheme (FSCS), which would safeguard the first £85,000 (as of January 2017) of your funds if they were held in a bank or building society and it went bust. So unlike savings in a bank or building society you capital is at risk if the borrowers you have invested in go bust.
Secondly, the advertised rate is not necessarily the actual rate you will get on your investment. This will be determined by the risk grade of the individuals or businesses you choose to lend to, how long you want to tie up your money for and the rates available at the time.
However, peer-to-peer operators have their own means of mitigating this extra risk, for example some share out your money among lots of different borrowers while others have a kind of insurance fund that investors collectively contribute towards, and which pays out should your loan be defaulted on.
Peer-to-peer lending websites also credit-check borrowers to ensure they can afford to repay your cash.
Are there any charges?
Peer-to-peer lenders are for-profit businesses that aim to make money. As an investor, you will therefore pay an annual servicing fee of about 1%, though this is generally taken into account in the advertised interest rates.
You will also face a fee if you need to access your money prior to the term agreed at the outset – for example three or five years.
Do I have to pay tax on my returns?
Not if you hold your peer-to-peer investments within an Individual Savings Account (ISA).
If you hold them outside an ISA, you can earn up to £1,000 a year in tax-free interest if you’re a basic rate taxpayer, or £500 if you’re a higher rate taxpayer. Earnings after that will be taxed at your normal rate.
Who to invest with
There are lots of different peer-to-peer lending websites too choose from. Two of the biggest consumer peer-to-peer lenders are currently Zopa and RateSetter while Funding Circle will lend your money to small businesses and Relendex will allow you to secure £5,000 upwards against commercial property investments.
Make sure you always know what you are getting into before investing your cash with a peer-to-peer lender and weigh it up against other options.