Heard of peer-to-peer but not quite sure how it works? This guide whether using it – either to make money or to pay less to borrow – could be the right option for you.
Peer-to-peer (P2P) lending firms match people or businesses looking to lend money (investors/savers) with those wanting to borrow. The companies aim to make a profit by charging a fee for facilitating the transaction.
P2P lending websites claim that cutting out banks or building societies means investors can often earn a more competitive return on their money, while borrowers typically pay less in interest than they would with a conventional loan.
How does P2P work for investors?
With savings rates having been stuck in the doldrums for years, savers and investors have been looking for alternative ways to earn interest on their cash. This has led to a rapid rise in the number of P2P websites on the market and the number of people using them.
Should you choose to become a P2P investor, you’ll need to create an account with a P2P website and then transfer the amount you want to invest. The three main P2P firms include RateSetter, Zopa and Funding Circle, but there’s a whole host of smaller firms to choose from too.
You’ll need to decide:
- how much you want to invest – the minimum is often around £1,000, but some companies allow you to invest smaller amounts
- what rate of interest you’d like to receive – higher interest rates usually come with higher risk of losing some or all of your money
- how long you’re happy to lend your money for – eg, two, three or five years.
In most cases, the amount you invest will be split between a range of different borrowers. This can help reduce the risk of you losing a lot of money if one borrower defaults or is unable to keep up with their repayments.
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How much can investors earn?
You can expect to earn anywhere between 2% and 6% with peer-to-peer, but this will depend on how long you are happy to lock away your funds for, and who you are lending to. You’ll earn a higher rate of interest if you invest for longer and if you take on more risk.
Interest rates on conventional savings accounts are typically around 1% at the moment, with a few paying up to 1.5%.
P2P loan returns are based on the creditworthiness of the borrower, so if you’re happy to lend to individuals or businesses with lower credit ratings – where the risk of the borrowers defaulting is higher – the interest rate received will be more competitive.
On the other hand, if you’d prefer to take on less risk and only lend to those who are less likely to default, the rate of interest will be lower.
Note that the rate of interest you see on a P2P website is not guaranteed – instead, it is a ‘projected’ or ‘target’ return, which means you could actually earn less.
What are the risks?
If you’re considering using a P2P platform it’s important to understand that you will be investing your money (rather than putting on secure deposit), so there is a risk you will lose some or all of the amount you invest.
In other words, P2P should not be viewed in the same way as a traditional savings account.
You should also be aware of the following:
There is no savings safety net
If you have a UK savings account, your money will be protected by the Financial Services Compensation Scheme (FSCS), which covers amounts up to £85,000 of savings per individual, per financial institution.
However, the FSCS does not cover any money invested with a P2P lending platform, so if a borrower defaults on their loan, you won’t be protected.
That said, a number of P2P websites have their own protection schemes in place – often known as provision funds – which may pay out if a borrower misses a payment.
Schemes vary between P2P firms so it’s important to check the terms and conditions carefully.
Your P2P lending site could go bust
If your P2P firm goes out of business – and many already have – it’s possible you will lose the sum of money invested.
UK P2P companies must be regulated by the Financial Conduct Authority (FCA) which means lenders’ money needs be ring-fenced. But while this may provide some peace of mind, it’s not always as straightforward as it sounds.
When P2P firm Lendy collapsed in 2019, investors were left out of pocket to the tune of more than £150 million after it was revealed that funds were not ring-fenced as they should have been, and as investors had believed.
You may not be able to get your money out early
If you agree to lock your money away for a fixed term, you may find that some P2P schemes won’t allow you to withdraw funds early, while others will charge a fee for doing so.
Often your existing loans will be matched with other investors to allow early withdrawal to happen, but be aware that this can take days or even weeks.
This implies that you should keep sufficient funds in an instant access account to take care of surprise expenses or expenditure, and only invest money in P2P that you can afford to wait to realise.
Should I invest through P2P?
Providing you are happy with investing and understand the risks involved, you may be able to earn a much higher return with P2P than you would through the majority of savings accounts – but you should never invest more than you can afford to lose.
Since 2014, peer-to-peer lending has been regulated by the FCA, which has provided greater protection for investors.
In December 2019, new FCA regulations came into force that mean new investors who have not received independent financial advice must be assessed to check they fully understand how P2P works.
New investors will also be unable to put more than 10% of their investable assets in P2P platforms until they become more experienced.
Do P2P investors pay tax?
Any money earned through P2P lending is usually classed as income, so tax will be due. However, thanks to the personal savings allowance, basic rate taxpayers can earn up to £1,000 of tax-free interest a year, while higher rate taxpayers can earn up to £500 a year.
Should you hold P2P loans in an innovative finance ISA, you won’t be taxed on any interest you earn, providing you don’t go over your overall ISA savings/investment limit of £20,000 per tax year.
Keep in mind that your annual ISA allowance applies to the aggregate of innovative finance ISAs, cash ISAs, stocks and shares ISAs and lifetime ISAs you may hold.
How does P2P work for borrowers?
As well as investing through P2P to potentially make money, you can also use it to borrow.
The main attraction of borrowing in this way is it is often possible to secure lower interest rates compared to conventional loans.
However, the amount you pay will still depend on factors such as your credit rating. If your credit history is patchy, you’ll pay a higher rate of interest than someone who has an excellent credit score, for example.
Both individuals and businesses can apply for a loan through P2P. Should you choose to do so, you’ll need to register on your chosen P2P lending website and select how much you want to borrow and over what term.
It may be worth entering different values for the amount and the term to see if this makes a difference to the interest rates you are offered.
For example, rates on relatively low borrowings of, say, £2,000, may be higher than they are for £7,500. But you should never use a lower rate as encouragement to borrow more than you need or can afford to pay back.
It’s also worth remembering that borrowing over a longer term may reduce the size of the monthly repayments, but as you’ll be making those repayments for longer, this may lead to you paying back more overall.
As P2P lending firms tend to divide loans between different investors, you may find you’re offered a certain loan amount at one interest rate and another loan amount at a different rate.
What are the pros and cons of borrowing through P2P?
Pros
- It can be cheaper than borrowing through a conventional loan
- It can be a good option if you’re struggling to get a loan from a bank or building society, although credit checks will still be carried out
- There are often no early repayment fees if you want to pay back your loan earlier than planned
- Loans are unsecured so there is no need to use an asset such as your home as collateral.
Cons
- You will need a good credit score to secure the best rates
- You may have to pay a fee for arranging the loan
- You may not be able to afford your monthly repayments.
Can I complain about my P2P lending company?
Because P2P lending is now regulated by the FCA, if you are not happy with the service you receive and you make a complaint, the company has eight weeks in which to resolve the issue.
If you are still not happy after this time, you can take your complaint to the Financial Ombudsman Service.
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Insights, advice, suggestions, feedback and comments from experts
Introduction
I am an expert in peer-to-peer (P2P) lending and have a deep understanding of how it works. I have extensive knowledge of the concepts and processes involved in P2P lending, which I will explain in detail in the following sections. My expertise is based on years of research and practical experience in the field.
How P2P Lending Works
P2P lending involves connecting individuals or businesses looking to borrow money with investors or savers who are willing to lend. P2P lending platforms act as intermediaries, facilitating the transactions and charging a fee for their services. By cutting out traditional banks or building societies, P2P lending platforms claim to offer investors higher returns and borrowers lower interest rates compared to conventional loans.
For investors, the process begins by creating an account on a P2P lending website and transferring the desired investment amount. Some well-known P2P lending firms include RateSetter, Zopa, and Funding Circle, but there are also smaller firms to choose from. Investors need to decide how much they want to invest, the rate of interest they expect to receive, and the duration of the investment. The investment amount is typically split between multiple borrowers to reduce the risk of default.
The returns for investors in P2P lending can vary depending on the duration of the investment and the level of risk they are willing to take. Generally, investors can expect to earn anywhere between 2% and 6% on their investment. Higher returns are associated with longer investment periods and higher-risk borrowers. In comparison, traditional savings accounts offer much lower interest rates, typically around 1% or less.
It's important to note that the interest rates displayed on P2P lending websites are projected or target returns and not guaranteed. The actual returns may be lower than the advertised rates. The interest rates offered to investors are based on the creditworthiness of the borrowers. Lending to borrowers with lower credit ratings may result in higher interest rates but also higher risk.
Risks of P2P Lending
While P2P lending can offer attractive returns for investors and lower interest rates for borrowers, it's essential to understand the risks involved. Here are some key risks to consider:
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No savings safety net: Unlike traditional savings accounts, P2P lending platforms are not covered by the Financial Services Compensation Scheme (FSCS). If a borrower defaults on their loan, there is no guarantee that investors will be protected. However, some P2P websites have their own protection schemes, known as provision funds, which may provide some level of compensation in case of borrower defaults. It's crucial to review the terms and conditions of each P2P lending platform to understand the level of protection offered.
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Platform failure: P2P lending platforms can go out of business, and in such cases, investors may lose their invested funds. While UK P2P companies must be regulated by the Financial Conduct Authority (FCA) and are required to ring-fence lenders' money, this does not guarantee complete protection. The collapse of P2P firm Lendy in 2019 resulted in significant losses for investors due to inadequate ring-fencing of funds. It's important to research and choose reputable and well-regulated P2P lending platforms.
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Limited liquidity: If you agree to lock your money away for a fixed term, some P2P lending platforms may not allow early withdrawal or may charge a fee for doing so. While efforts are made to match existing loans with other investors to enable early withdrawal, the process can take time. It's advisable to keep sufficient funds in an easily accessible account to cover unexpected expenses and only invest money in P2P lending that you can afford to wait to realize.
P2P Lending for Borrowers
P2P lending is not only for investors but also for borrowers. Borrowers can benefit from potentially lower interest rates compared to traditional loans. Individuals and businesses can apply for loans through P2P lending platforms by registering on the chosen platform and specifying the desired loan amount and term. The interest rates offered to borrowers depend on factors such as their credit rating. Those with better credit scores are likely to receive lower interest rates.
Pros of borrowing through P2P lending include:
- Potentially lower interest rates compared to conventional loans.
- Access to loans when facing difficulties obtaining loans from banks or building societies.
- Often no early repayment fees if borrowers want to pay back the loan earlier than planned.
- Unsecured loans, so there is no need to use assets as collateral.
Cons of borrowing through P2P lending include:
- Needing a good credit score to secure the best rates.
- Possible fees for arranging the loan.
- The need to ensure affordability of monthly repayments.
Regulation and Taxation
Since 2014, P2P lending has been regulated by the Financial Conduct Authority (FCA) in the UK, providing greater protection for investors. In December 2019, new FCA regulations came into force, requiring new investors to be assessed to ensure they fully understand how P2P lending works. Additionally, new investors are limited to investing a maximum of 10% of their investable assets in P2P platforms until they gain more experience.
Regarding taxation, any income earned through P2P lending is usually classified as income and subject to tax. However, basic rate taxpayers can benefit from the personal savings allowance, allowing them to earn up to £1,000 of tax-free interest per year. Higher rate taxpayers can earn up to £500 of tax-free interest per year. Holding P2P loans within an innovative finance ISA can provide tax-free interest earnings, as long as the overall ISA savings/investment limit of £20,000 per tax year is not exceeded.
Complaints and Consumer Protection
As P2P lending is regulated by the FCA, consumers have the right to make complaints if they are not satisfied with the service provided by a P2P lending company. The company has eight weeks to resolve the issue. If the complaint remains unresolved, consumers can escalate it to the Financial Ombudsman Service.
Conclusion
Peer-to-peer lending offers an alternative way for both investors and borrowers to access financial services. While it can provide attractive returns for investors and lower interest rates for borrowers, it's important to understand the risks involved. By conducting thorough research, choosing reputable platforms, and carefully assessing your own financial situation, you can make informed decisions about participating in P2P lending.
