Everyone can benefit from peer-to-peer finance!

The peer-to-peer industry has taken off dramatically in the last few years, as savers look for alternative ways to earn a decent return on their money. But it's not only savers who can benefit from peer-to-peer lending – borrowers can too.

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Updated 25.04.16

Here, we take a closer look at how peer-to-peer lending works.

What is peer-to-peer lending?

Peer-to-peer lending works by matching up people who want to earn a return on their money with those who want to borrow money. Borrowers can be individuals or small businesses.

When compared to banks and building societies, peer-to-peer lenders have lower operating costs and are therefore often able to offer higher interest rates for savers and lower interest rates for borrowers.

It's for this reason that peer-to-peer is growing in popularity.

In fact, despite only launching in the UK in 2005, by the last three months of 2015 lenders had provided more than £4.4 billion in funds to UK borrowers, according to the Peer2Peer Finance Association.

And over the past year or so, an increasing number of peer-to-peer lenders have sprung up on the market, giving borrowers and savers much greater choice.

Do I have to pay tax on my returns?

Since April 2016 you can invest your funds in a new kind of ISA – the Innovative Finance ISA - which means you don’t pay any tax on your returns.

Eight peer-to-peer lenders have been authorised by the Financial Conduct Authority to offer Innovative Finance ISAs so far.

If you invest outside an Innovative Finance 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.

What should I be aware of?

The main catch with peer-to-peer lending is that money invested will not be protected by the Financial Services Compensation Scheme (FSCS), as it would be in a traditional savings account. The FSCS protects the first £75,000 of your funds should your bank or building society collapse.

This means that investing in the peer-to-peer sector comes with more risk. However, peer-to-peer operators mitigate this risk by often sharing out your money among different borrowers and credit checking borrowers to ensure they can afford to repay your cash.

Since April 1, 2014, there’s more protection for peer-to-peer investors because they became regulated by the Financial Conduct Authority. The new rules state that all peer-to-peer firms must be honest about the risk and also have contingency plans in case anything goes wrong – including building up a financial buffer.

Some lenders, such as RateSetter and Zopa, have a safeguard facility in place for their lenders – essentially a pot of money to cover losses in the event that a borrower defaults.

Lenders contribute to RateSetter's Provision Fund via their 'credit rate'. If a payment is missed, lenders can claim through the fund to ensure they get their money back.

Meanwhile, Zopa's Safeguard is a fund held in trust by a not-for-profit organisation, which means Zopa has no rights to the money in it. Should a borrower default, you as a lender should be able to claim your money back through the Safeguard.

Who are the different players and what do they offer?

Zopa

Zopa was the first peer-to-peer lending company, launching in 2005. Savers have a choice of three products; the first is an Access account where it’s possible to dip into your money if you need to and with no fee, although you will need to rely on other savers buying your loans in order to withdraw the cash. That account offers a projected return of 3.5% a year, factoring in expected losses.

The second option is the Zopa Classic account, paying an anticipated return of 4.5% a year but with a 1% fee to sell your loans and get your money back.

Finally, if you’re willing to take on more risk there’s the Zopa Plus rate, offering a projected return of 6.5% a year and without the Safeguard cover that protects the other two accounts. Again, there’s a 1% fee for selling your loans to access your cash. 

You can lend from as little as £10 (although the Plus account requires a minimum investment of £1,000), which means you can test the water first to see whether peer-to-peer lending is right for you.

Borrowers, meanwhile, can enjoy rates as low as 3.3% APR representative on loans between £7,500 and £15,000, providing the loan is repaid over two to five years. This rate includes a fee, the total of which depends on what’s being borrowed.

RateSetter

RateSetter is another of the larger peer-to-peer lenders and launched in 2010.

If you're a saver/lender happy to tie up your money for five years, you can take advantage of RateSetter's 5 Year Income account which offers an annualised return of 5.9%. The minimum you can invest is £20.

Alternatively, RateSetter's 3 Year market account offers a return of 2.9%, with a minimum investment of £20, and its 1 Year market account pays an impressive 3.5%, with a minimum investment of £10.

If you'd prefer not to tie up your funds, the RateSetter Rolling market option only requires a short-term commitment of 30 days and pays 2.80% on a minimum investment of £10. You can withdraw your funds from this account as long as there is another saver/lender who is willing to buy the loans off you. So far that has always happened, but there’s no official guarantee.

Borrowers, meanwhile can take advantage of loan rates of between 4.2% APR representative and 11.1% APR representative on a £5,000 loan of between one and five years. The rates include fees, the total of which depends on what’s being borrowed.

Funding Circle

Funding Circle was also launched in 2010, but rather than lending to individuals, it enables you to lend to businesses.

Savers/lenders can earn a current estimated return of 7.40% on their money a year after fees and bad debt. However, this is not necessarily the rate you will get as this will depend on the exact rates you choose to lend at, the risk grade of the businesses you lend to, and any losses you might experience. Businesses are graded from A+ to E, with A+ being the lowest risk.

The minimum investment amount is £20. Should you need to get access to your money, you can sell your loans to other investors - but there is a 0.25% sale fee.

Relendex

Relendex is relatively new to the peer-to-peer marketplace and operates slightly differently as lenders' money is secured against commercial property investments.

You choose which property you wish to lend on, over what term and at what rate. You'll be able to view all of the information about the property, including its location, tenancy schedule, lease profiles and rental income on the website. You can also select the category of risk you're prepared to take as each property is categorised from A+ to C.

The minimum investment amount is at least £500 per loan.

The company promises returns of up to 10% per annum, which is paid quarterly, although the specific returns anticipated on loans depending on the property you choose to bid on. As an example, investors who choose to invest their money in one of the current opportunities - a Surrey residential redevelopment - could potentially earn 10% on their cash over 12 months, although this is listed as an A-category risk.

Should you need to get out of your loan early, you can resell it through the Relendex website, though you will pay a sale fee of 1%.

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

Peer-to-peer lending is regulated by the Financial Conduct Authority, but your money is NOT protected by the Financial Services Compensation Scheme. There is a risk you may lose some or all of your initial investment.

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