Pros and cons of peer-to-peer lending

Updated March 31, 2016

Fed up with more than half a decade of terrible returns on your savings?

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It won't cost you anything to at least take a look at peer-to-peer lending which - in a nutshell - allows you to lend your cash to individuals, small businesses or even property investors, who then pay you back with interest.

Here are some pros and cons of this rapidly-growing industry:

Pros …

1. You’ll get a much higher rate than most savings accounts pay

Returns offered by peer-to-peer websites tend to be much higher than those offered by savings accounts. For example, one of the top 5-year fixed rate bonds is from Union Bank of India which pays 3.00% AER. This compares to a projected annual interest rate of 6.32% with peer-to-peer lender, Wellesley, over the same term.

2. You can diversify where you put your money

Peer-to-peer lending isn’t just about lending to individual consumers looking for a loan – there are a growing number of different schemes and businesses you can lend money to.

Landbay and Wellesley & Co for example, enable you to lend to residential property investors – meaning you can invest in bricks in mortar without actually buying a house. Your cash will be lent across several properties which are all lived in by tenants.

Or, if you’re interested in investing ethically, Assetz Capital allows you lend directly to renewable and sustainable energy projects.

3. Peer-to-peer is covered by FCA regulation

Since April 1, 2014, the peer-to-peer industry has been regulated by the Financial Conduct Authority (FCA). This means all peer-to-peer lending websites have to be clear and upfront about risks and have plans in place in case something goes wrong. From April 2017, peer-to-peer providers will need to show they have at least £50,000 as a buffer in case they run into financial difficulties.

4. Schemes offer their own protection

Recognised peer-to-peer schemes offer their own ‘provision funds’, built up from borrowers’ fees, so that if borrowers default on their loans, lenders won’t lose out.

Funds like these are held by independent third parties, so that there’s no conflict of interest. As an example, RateSetter's provision fund holds just over £17m which offers 132% of cover against predicted claims.

5. You can take your money out if you need to

Although you often have to commit to lending your money out for a set term, most peer-to-peer lenders enable you to take out your cash if you need to. For example, RateSetter has a ‘sell out’ function, which enables you to sell on your contracts as long as there is another lender available to match your existing loans.

6. You can invest tax-free

Since April 2016, you can hold peer-to-peer loans within an ISA so that returns are tax-free. This type of ISA is called an Innovative Finance ISA and you can invest up to £15,240 into ISAs this tax year - in cash, peer-to-peer loans or stocks and shares, or a combination of all three.

Cons…

1. Your cash WON’T be covered by the FSCS

This really is the big one. Peer-to-peer lending is NOT covered by the Financial Services Compensation Scheme (FSCS). This government scheme pays out up to £75,000 per person, or £150,000 for joint accounts, per financial institution, in the event that your bank or building society goes bust – highly unlikely but a safety net for your life savings is not to be sniffed at.

2. You may have to lock up your cash

Many peer-to-peer schemes require you to lock up your funds for at least a year. If you want to access your cash before the loan ends, there may be charges to pay or you may lose out on some interest.

However, as mentioned, you are often able to get access to your cash, so long as other investors are available to take your place.

3. You might have to wait for your money to be lent

How quickly your money is lent out to borrowers once it’s been paid into the peer-to-peer ‘pot’ depends on who is looking to borrow at any particular time. It could be that your funds are immediately matched with people needing a loan, or you might have to wait several days – during which time you may not earn any interest.

Wellesley & Co says you will start earning interest even before your funds are matched. RateSetter, however, says you will only earn interest once the funds are lent.

Whichever peer-to-peer lender you choose to invest with, this is something worth checking.

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.

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