Many savers are turning to peer-to-peer lenders, which match up savers or investors with individuals or companies looking to borrow money.
The popularity of these lenders, which include Zopa, Funding Circle, Ratesetter and Wellesley & Co, has rocketed over the past few years. The size of the peer-to-peer lending sector more than doubled in 2013 alone and in 2015 both Zopa and Funding Circle broke the £1 billion-lent barrier.
And with the Financial Conduct Authority (FCA) stepping in to regulate the sector and bolstering confidence as a result, not to mention the new Innovative Finance ISA that allows investors to earn tax-free returns on their lending, yet more savers and borrowers are likely to be enticed by the attractive returns and low loan rates on offer.
Peer-to-peer lending carries risks for savers, though. So we’ve put together this back to basics guide to help both savers and borrowers understand how peer-to-peer schemes work.
Savers (or ‘lenders’)
What is peer-to-peer lending?
By investing in a peer-to-peer scheme, you are essentially taking the place of a financial institution such as a bank by agreeing to lend money to people or businesses via an intermediary – the peer-to-peer lender.
The peer-to-peer company will usually spread your investment over many borrowers to reduce the impact 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.
As with a bank loan, the rate charged will relate to the level of risk involved.
In some instances, you can therefore decide whether you want to take the risk of lending to people with lower credit scores in return for a higher interest rate, or accept a lower rate in return for the security of lending to people with better credit ratings.