Lending using a peer-to-peer website - Investments - Guides | moneyfacts.co.uk


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Lending using a peer-to-peer website

Category: Investments
Author: Tim Leonard
Updated: 14/06/2018

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 with the banks, it is less.

However, there's a catch for those who invest with a peer-to-peer (P2P) 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 (FSCS). So read on for Moneyfacts.co.uk's guide to lending through a peer-to-peer website…

(If you're thinking of borrowing through a peer-to-peer lending website rather than lending, please read the linked guide for all the details.)

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 in 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 peer-to-peer lending as making an investment instead.

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

The P2P market is now regulated by the Financial Conduct Authority (FCA), although not in the same way as banks and building societies. Under the new regulations, P2P lenders must provide "fair, clear and not misleading" information for consumers to help them understand the higher level of risk involved and make better financial decisions.

Some key points under the FCA regulations that give users a little more security are:

  • P2P lenders must keep client funds separate from their own money. This means that any funds or repayments are held in a third-party account.
  • P2P lenders must have reasonable steps in place to manage the repayments and collections in the event of a firm collapsing.
  • P2P lenders must hold a set level of capital to withstand any financial shocks in the future. This does not include having a mandatory safeguard fund to further protect savers.
  • Borrowers that have a change of heart and do not wish to continue with the loan have a 14-day period to change their mind and cancel the loan agreement.
  • The FCA is introducing rules to give investors the right to complain, first to the firm and then, if relevant, to the Financial Ombudsman Service.

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 of 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. Many P2P sites have set up their own ways of protecting their investors, but you must remember that this is not the same as the protection offered by the FSCS.

RateSetter has set up its own 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 there's a much higher than anticipated bad debt rate, and the provision fund is exhausted, you still have the potential to lose money.

Zopa has a Safeguard Fund which stands at over £3 million ready to step in and pay out in the event of a borrower defaulting on their loan, and it also diversifies savers' funds across hundreds of borrowers to provide further protection and minimise risk.

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). The borrower will also usually pay a fee for their loan.

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.

What about tax?

Interest earned on a peer-to-peer loan is treated the same way as interest on a regular savings plan. Up to the first £1,000 of interest in any tax year is now tax-free under the Personal Savings Allowance, and peer-to-peer loan interest counts towards this. The interest will be paid gross, and if you earn over your Personal Savings Allowance you will need to disclose this to HM Revenue & Customs to settle any tax you need to pay.

From April 2016, peer-to-peer loans can also be held as ISAs. These are called Innovative Finance ISAs, and you can use your entire year's ISA allowance for these ISAs.

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, but rather 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, but in general peer-to-peer lending is not suitable for money that you know you're going to need access to quickly.

Some P2P websites such as RateSetter offer a Rolling Monthly Loan that allows you to cancel your contract within two working days' notice, however this comes at a price - you would earn more interest if you can commit your money for longer, but remember that you then won't have access for the full term.

An alternative offered by some P2P websites such as Zopa is to sell your loan on to another lender in order to get earlier access, but there will most likely be a 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.

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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.