Guides

Lending using a peer-to-peer website

Lending using a peer-to-peer website

Category: Investments

You might have heard of the likes of Zopa, RateSetter or Funding Circle – peer-to-peer lending websites that allow investors (lenders) to find borrowers and vice versa, matching them up in order to give more profit to the lender, and lower rates to the borrower. This is achieved through taking banks and building societies out of the equation, and the wedge of interest they normally earn. That's not to say that the peer-to-peer websites don't take their cut, but, when compared to the banks, it is less.

However, there's a catch for those who invest with a peer-to-peer website – you could lose money and, because of the nature of your investment, you wouldn't be covered under the terms of the Financial Services Compensation Scheme. So read on for moneyfacts.co.uk's independent guide to lending through a peer-to-peer website…

If you are thinking of borrowing through a peer-to-peer lending website, please read this guide.

All a bank does is lend my money to someone else, so how is peer-to-peer lending any different to putting my money in a savings account?

It's true to say that when you deposit your savings with a bank or building society; they use some of your money to lend out to other customers.

However, with peer-to-peer lending there is a fundamental difference between where the risk lies…

Savings Accounts Peer-to-Peer lending
Risk If a borrower defaults on a loan that your money has been used to fund, you wouldn't lose anything – the bank or building society absorbs the loss. If a borrower defaults on a loan that your money has been used to fund, you would lose your money – you absorb the loss.
Reward Savings accounts can pay lower rates of interest than you could earn as a peer-to-peer lender, because you are taking no investment risk with your money. You can earn higher rates of return as a peer-to-peer lender because you take the investment risk of losing your money.

So to summarise:

Savings account – their risk, less reward.

Peer-to-peer – your risk, greater reward.

Because you are taking the risk of losing money, the comparison with a savings account is not useful – in fact it can muddy the water.

Therefore you should view lending peer-to-peer as making an investment instead.

What happens to my money if a peer-to-peer lending website goes bust?

As a peer-to-peer lending website acts as a matchmaker between you and a borrower, it isn't (under current rules) regulated by the Financial Conduct Authority, nor can it be part of the Financial Services Compensation Scheme.

Consequently there is the risk that you could lose some or all of your money if the website went bust.

However, in practice there are some safeguards in place to protect your money.

  • Money already lent out to borrowers would be safe in the event that the website went bust (although it would still be at risk of the borrower defaulting). Both you and your borrower will still be obliged to honour the credit agreement and its terms until the loan is repaid.
  • Money not lent may be ring fenced from creditors in a segregated account. Be sure to check this out before committing your money.

What happens if one of my borrowers defaults?

It is advisable to spread your money between lots of different borrowers – you can usually do this in chunks as little as £10 to limit your exposure to the risk of default.

However, in the unfortunate event that a borrower defaults, you could lose your money.

RateSetter has set up its own, unique bad loan provision fund designed to cover against anticipated losses. At the time of writing the RateSetter Provision Fund covers the anticipated default rate nearly five times over. However, if RateSetter loans experience a much higher than anticipated bad debt rate, and the provision fund is exhausted, you still have the potential to lose money.

That said, the RateSetter Provision Fund is unique among peer-to-peer lending websites (Zopa, YES-secure, etc. don't have a bad debt provision fund, although several are said to be looking into the possibility).

What fees do I have to pay?

The peer-to-peer lending website makes money from both you and the borrower. You will have to pay a fee (normally either an initial fee that's a percentage of the amount you lend, or a percentage of the amount of interest you receive).

If you are allowed to access your money before the end of a loan term, you may also have to pay a percentage of the cash you've lent to get out.

What about tax?

Interest you earn from your loan book will be treated as investment income for Income Tax purposes.

The peer-to-peer website you lend through will send you an annual statement of interest earned which you will then need to declare through your Self Assessment Tax Return.

What types of borrowers will my money be lent to?

That's the great thing about peer-to-peer lending – you decide. This doesn't mean you get to go round to their houses for a cup of tea and assess their ability to pay (!), rather it means that you can specify the "type" of borrower you lend to.

Categories range in order of risk, with A* being the lowest risk borrower type. The higher the risk of borrower, the higher the rate you can charge, but bear in mind that higher risk means just that – more chance of you losing your money.

Some peer-to-peer websites allow you to find out what the borrower needs the money for, but you need to be careful with this more personal approach, as it could cloud your judgement to the financial merits of lending to one borrower over another.

What if I need quick access to my money?

You should look at peer-to-peer lending as an investment activity, where your money could be tied up for a few years at a time. This is not to say that you can't access your funds; however, in general peer-to-peer lending is not suitable for money you know you're going to need access to quickly.

RateSetter offers a Rolling Monthly Loan that allows you to cancel your contract with two working days' notice. However, this rolling loan option comes at a price – you would earn more interest if you can commit your money for longer. With RateSetter you can't cancel their other lending option, a three year loan – your money will be committed for the full term with no access.

Alternatively, Zopa allow you to sell your loan on to another lender in order to get earlier access, for a 1% transfer fee. There is one catch to this – if your borrower has ever missed a payment, you won't be able to transfer your loan.

Can I include my peer-to-peer lending in a SIPP or ISA?

Under the current rules, you can't include any peer-to-peer lending in an ISA or SIPP wrapper.

What Next?

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Compare personal loans with peer-to-peer loans

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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