Notes from 'Money Matters' meeting on 15th October
The popularity of these lenders, which include Zopa, FundingCircle, RateSetter, FundingKnight, AssetzCapital, eMoneyUnion, ReBuildingSociety, LendInvest, SavingStream, AbundanceGeneration and Wellesley & Co., has rocketed over the past few years. The size of the peer-to-peer lending sector more than doubled in 2014 alone.
And with the Financial Conduct Authority (FCA) stepping in to regulate the sector and bolstering confidence as a result, yet more savers and borrowers are likely to be enticed by the attractive returns and low loan rates on offer.
Peer-to-peer lending carries risks for savers, though. The following is a brief guide to help 'Money Matters' members understand how peer-to-peer schemes work.
What is peer-to-peer lending?
By investing in a peer-to-peer scheme, you are essentially taking the place of a financial institution such as a bank by agreeing to lend money to people or businesses via an intermediary - the peer-to-peer lending platform
Some platforms will automatically spread your investment over many borrowers to reduce the impact should one of the borrowers default on his or her loan. If you lend £2,000 through Zopa, for example, the sum could be split between at least 200 borrowers.
As with a bank loan, the rate charged will relate to the level of risk involved.
Often, you can decide whether you want to take the risk of lending to people with lower credit scores in return for a higher interest rate, or accept a lower rate in return for the security of lending to people with better credit ratings.
How does peer-to-peer saving work?
To set up an account with a peer-to-peer platform, you will have to supply personal information such as your name and address, choose how long you want to tie your money up for (and in some cases, at what rate) and transfer across the cash you want to invest.
Are there any charges?
Most peer-to-peer lenders charge an annual servicing fee of about 1%. But the good news is that any charges are usually taken into account in the advertised rates. RateSetter, for example, includes its fee (of 10% of the interest charged) in the interest rates it offers on all its accounts.
There will, however, be further commission to pay should you need to access your money prior to the term agreed at the outset, which could be, say, three or five years.
This is because the returns on offer generally increase the longer you agree to tie your money up for - just as they do with fixed-rate savings accounts.
What are the advantages?
The superior returns available are the most obvious advantage of peer-to-peer lending. Many peer-to-peer schemes pay more than 6%, which is significantly more than you can get on a standard savings account at the moment.
The terms are also more flexible than those you will find on most savings accounts.
Most peer-to-peer lenders allow you to invest as little as £10 or £20, while imposing no upper limit on the amount you can invest (although the FCA does not want people putting in more than 10% of their total investment portfolio due to the risks involved).
What are the disadvantages?
There are some risks with peer-to-peer lending. For example, the advertised rate is not necessarily the rate you will receive.
This is because the returns you achieve will depend on the exact rates you choose to lend at, the risk grade of the people or businesses you lend to, and any losses you might experience.
What's more, although the peer-to-peer market is now under the auspices of the FCA, savers do not qualify for protection under the Financial Services Compensation Scheme (FSCS). Customers of conventional banks and building societies have protection for the first £85,000 of their funds should their bank or building society collapse.
Peer-to-peer platforms try to mitigate the risks involved by splitting your money between many borrowers and carrying out credit checks on those looking for loans. Most lenders also maintain a compensation fund to cover losses in the event that a borrower defaults.
Wellesley & Co, for example, has a Provision Fund that is held in trust by a vetted independent third party and contains double the funds needed for savers to be reimbursed.
And Zopa's Safeguard fund, which is also held in trust, currently holds more than £3 million compared to a maximum estimated default of under £2.3 million.
Do I have to pay tax on my returns?
Thanks to a change announced in the 2014 Budget, peer-to-peer saving/lending will soon be enabled within a tax-efficient New Individual Savings Account (NISA).
However, this is not expected to become possible until April 2016, so you will be liable for tax on the returns you receive until then.