The peer-to-peer lending market has grown steadily since it was first introduced in 2005, and has proved popular with savers seeking returns that can keep pace with rising living costs.
Over the past couple of years, standard savings accounts have offered very low interest rates after the Bank of England base rate plummeted to a historic low of 0.1% at the onset of the coronavirus pandemic. This prompted savers to consider other ways to save, with peer-to-peer lending appearing an attractive option due to the promise of competitive returns. However, there are several major downsides to consider, not least that there’s no savings safety guarantee with peer-to-peer lending, and it can be difficult to withdraw your money quickly. The good news for savers is that interest rates are rising, pushing up returns on standard accounts, although currently no savings accounts – including peer-to-peer accounts – pay returns which match or beat inflation
Additionally, some of the biggest peer-to-peer lenders have withdrawn from the market, including Zopa and Ratesetter, so the choice is limited. Meanwhile, peer-to-peer lending has received some criticism over recent years, with the Financial Conduct Authority (FCA) stating it is a “high-risk investment”. Some smaller providers have also collapsed over recent years, which has added to the turmoil faced by the P2P sector.
Here we explain what peer-to-peer lending is, who the major players are, what the risks are, and how to invest if you think it might be right for you.
What is peer-to-peer lending?
Peer-to-peer lending involves your money being lent to individuals or small businesses who need a loan and who will pay you interest on the money they have borrowed.
If you invest in peer-to-peer lending, you will usually do this through an online platform, which brings together parties that want to lend money and those that want to borrow it. Acting as an intermediary and administrator, the platform will usually charge a small fee to both parties for its services.
Most platforms look for a starting investment of around £1,000, although some allow you to invest smaller sums, and offer interest rates up to about 6%. With general savings accounts currently offering from just 0.1% and 0.6%, it’s easy to see why peer-to-peer lending might appeal.
However, investing in peer-to-peer lending comes with major caveats, and it’s important to fully understand the risks involved. It’s not the same as putting your money into a normal savings account. While removing banks from the equation means better returns for investors and cheaper loans for borrowers, there are far fewer safeguards for savers, so there’s a risk you could lose some or all of your money.
How does peer-to-peer lending work?
If you want to become a peer-to-peer lender, you simply invest your chosen amount with a peer-to-peer platform. The platform lends this money to borrowers and they then repay the money you’ve lent them with interest over an agreed time period. So far, so simple, but there are a few factors you need to understand before you hand over your money:
How do platforms work?
Some peer-to-peer lending platforms in the UK include Assetz Capital, Market Finance and Funding Circle. However, some aren’t currently taking on new investors unless you have a large sum to invest, although you may be able to sign up to a waiting list.
Different platforms specialise in providing loans for different things. So for example, Assetz Capital focuses on secured loans. With these different loans comes varied levels of risk, which you will see affect the interest rates each platform offers.
Generally, when you decide to invest your money in any platform, they use it to fund loans in one of two ways:
Parcelling up – This involves investments from a number of lenders being bundled together and dispersed amongst multiple borrowers. One of the main reasons for this method is to help spread the risk that the borrower defaults (doesn’t pay back) on their loan.
Selective – The riskier alternative for the lender, this involves them choosing exactly who they would like to lend to. The key risk here is that your entire investment is placed in the hands of one borrower, and if they’re unable to repay their loan, you could lose your money.
If your investment has been parceled up with others, you may have a bit more flexibility when it comes to accessing your money, but if you’ve lent to a specific individual directly, it’s unlikely you will be able to access your money before the end of the loan’s term.
Innovative Finance ISA
Some platforms will give you the option to invest in peer-to-peer lending via an Innovative Finance ISA.
This essentially provides you with all the features of peer-to-peer lending with the added benefit of a tax-efficient wrapper. You can read more on how Innovative Finance ISAs work in our article Everything you need to know about ISAs. Bear in mind, however, that interest earned from peer-to-peer lending is covered by the personal savings allowance. This allowance enables basic-rate taxpayers to earn up to £1,000 in interest each tax year free of tax, and higher-rate taxpayers up to £500, so you’ll only pay tax on interest in excess of these amounts if you invest outside an ISA. You won’t be eligible for a personal savings allowance if you’re an additional-rate taxpayer.
What interest rates do platforms offer?
The interest rates each platform offers will vary considerably. Depending on how the platform works, you may be able to opt for specific interest rates, or you will agree to an interest rate range with a minimum rate that you are happy to accept.
It’s worth noting that the difference in interest rates is usually due to the different levels of risk of each loan, with the risk being determined by the type of loan (i.e. a property development loan, personal loan, business loan etc), the length of the loan and how easily you can access your money. Generally, the higher the risk, the higher the returns you can potentially earn.
What are the risks of peer-to-peer investing?
There are several risks you’ll need to consider if you’re thinking of putting your money into peer-to-peer lending. These include:
The borrower defaults on their loan – This is one of the biggest risks to your money. If the person or business the platform has lent your investment money to doesn’t repay their loan, you may lose some, if not all of your money. Most platforms have a contingency fund that might pay out if your borrower defaults, so it’s important to check whether the platform you are considering offers this and if there are any other safeguards in place to protect your money.
The borrower repays early or late – The interest rate you sign up to is usually an average over the term of the loan to the borrower, so if they repay early you could lose some interest, and if they repay late, your money might be tied up for longer than you want.
The platform goes bust – It is possible that your peer-to-peer lending platform could go bust and take all of your money with it. Peer-to-peer lending isn’t covered by the Financial Services Compensation Scheme, which provides savers with up to £85,000 of their savings per person per savings provider, in the event that their provider goes bust.
The amount you invest will be limited if this is your first time using peer-to-peer lending – The FCA has guidelines that say that new peer-to-peer investors are only able to invest a maximum of 10% of their ‘investable assets’ in peer-to-peer lending. Your investable assets include any spare cash you have readily available, but not things like your home, where your money is tied up. However, if you’ve had financial advice before investing, you might be able to invest more than the 10% limit.
It can be tricky to get your money out – If you decide to withdraw your investment, it’s not as simple as sticking a card into a cash machine and drawing money out. Instead, you have to ‘sell’ your investment to another person, which means if there aren’t any buyers, you might face a lengthy wait before you can access your cash.
What are the advantages of peer-to-peer lending?
Although there are a number of risks there are some advantages to peer-to-peer lending:
Market-beating interest rates – With interest rates being as low as they currently are, one of the biggest advantages of peer-to-peer lending is the interest rates they offer, which can be anywhere up to around 6%
A range of options and risk levels to choose from, as well as more flexibility for your investment than more traditional investment methods.
Is peer-to-peer lending safe?
As with all investing, there is always the chance that you could lose your money, and peer-to-peer lending is often seen to be a riskier investment option. With peer-to-peer lending, because you are dealing with individuals and not businesses or banks so there is a higher chance that you could lose your money as well as the risks we highlight above that you might want to consider before rushing out to invest in peer-to-peer lending.
Of course, the whole point of peer-to-peer lending is to provide money for people to borrow, but you want to be sure that your money is being used safely, so it’s worth understanding what minimum criteria your platform has for its borrowers, and what due diligence it carries out.
How can you invest in peer-to-peer lending?
To invest in peer-to-peer lending there are three key steps:
Find a platform you want to invest in and select how long you want to tie your money up for.
Either set the interest rate you want or accept the platform’s standard rate – Some, but not all, platforms will let you set a minimum interest rate you are willing to accept. Once you’ve decided this, you open an account and transfer the money you want to invest.
Your money is then lent to borrowers – Different platforms do this in different ways. Some will automate the process and arrange your lending for you while some will require you to choose and offer individual loans yourself.
There is a wide range of platforms available, and it’s really important to do plenty of research before investing your money, so you understand how their approaches to interest, fees, protection and lending opportunity sourcing may differ.
Is peer-to-peer lending a good investment?
This is a rapidly changing industry, and it may be that you struggle to find a peer-to-peer lender currently accepting investors. Given the risks involved, that may be no bad thing. Some firms haven’t made it through the pandemic, and more borrowers have defaulted during difficult times, and left investors waiting to get their money back.
However, if you’ve done your research, and you’re comfortable accepting the risks involved, then peer-to-peer lending might be worth considering. Alternatively, you might prefer other options, such as a standard savings account, which will provide you with greater protection.