It seems that new “peer to peer lending” products and services are popping up every week, and with websites that bypass the banks by matching up savers and borrowers with claims of returns of between 10-15%, is it all too god to be true?
First and foremost, the idea of peer to peer lending is fairly straightforward. It puts savers with money to lend in touch with individuals or small businesses that need to borrow. The idea of these unsecured loans is that both parties benefit, as the rates are much better than those offered at other financial institutions. The biggest three companies currently in the market are Zopa, RateSetter and Funding Circle, but there are lots of others in the pipeline.
With a launch date of March 17th 2014 City “superwoman” Nicola Horlicks new peer to peer website Money & Co will allow people to lend small and medium-sized enterprises and enjoy returns of an estimated 8%, reducing to 7% after fees. The mother of six, whose business ventures already encompass the worlds of investment, movies and restaurants, told Guardian Money that out of all the things she has done in her career, “this is one of the most exciting. There’s a real need. It will help companies, help the economy, and help individuals to get a better return on their cash”. She believes the sector is still in its infancy, but adds: “I would expect us to be one of the winners … Our system is built to be global.”
The sites all work in different ways for savers, with those lending to businesses usually offered the higher rates. The mainstream ends of the sector are names you may be more familiar with such as Zopa and Rate Setter, while others are more niche. In the case of Zopa, the UK’s biggest peer to peer site, you choose how much you want to lend (the minimum being £10) and the period (between three to five years). The money is then lent in small chunks to a number of borrowers, and you receive repayments each month, made up of interest and the money you lent out, so as a saver you generally don’t have to wait long to see a return.
Zopa claim its lender investors can expect to make 4.9% interest over five years, after its 1% annual fee is deducted, or up to 3.9% over three years. Rate Setter this week quoted rates between 1.9%-5.5%, while Funding Circle, where people lend to businesses, says its investors are earning an average of 5.7% after fees and bad debt. Some of the newer sites are quoting slightly higher rates. Rebuildingsociety.com state an average gross yield of 15.6%, while Thin Cats boasts that lenders can earn between 6%-13%.
The Peer to Peer Finance Association, which is the industry trade body, confirmed that the sector more than doubled in size in 2013. This surge in popularity is mainly because of a perfect set of factors: years of rock-bottom interest rates that have prompted desperate savers to seek out alternatives; a lending freeze that has hit consumers and small businesses hard; and a string of financial scandals that have led to a loss of trust in Britain’s most conventional financial institutions. This has prompted individuals to look elsewhere for investment opportunities. But what are the risks? Firstly, there is little regulatory protection for investors and borrowers. However as of 1st April 2014 lenders will be regulated by the Financial Conduct Authority (FCA) which will ultimately mean greater protection for those that use them. There will also be new minimum capital requirements, rules to protect “client money”, and a requirement that steps are taken to make sure repayments on existing loans would continue to be collected if a site went bust.
However, peer to peer sites are not covered by the Financial Services Compensation Scheme which guarantees savings up to the value of £85,000, and more importantly, there are no plans to change this. Access to cash is also in most cases not instant. All the sites operate slightly differently, but it is worth noting, that your money could be inaccessible for several weeks, even months.
If you were perhaps thinking about investing or borrowing from a peer to peer scheme it is definitely advisable to do your research first. Look at mini-profiles and look on the company websites. Ask friends and relatives if they have used any of the companies and how they found the experience. You have to be aware of the risks. The FCA state that referring to the lender investors who use these sites as “savers” may be “problematic” because peer to peer is “higher risk” than putting your money in a savings account. If you’re not comfortable with this, it may not be for you. Perhaps the most obvious risk however, is that if a borrower fails to pay you back. However, several of the sites operate a fund or similar scheme that will cover a lender’s losses in the event that a borrower is unable to repay. Zopa has the “Safeguard” fund while Rate Setter has the “Provision Fund”. In theory you could also lose some or all of your money if the peer to peer website itself got into financial difficulty, because these are not covered by the FSCS.
Many of the sites insist that monies not out on loan are held in a ring fenced account, and that in the event of any issues arising, your contracts with borrowers would remain in force, and they would be contractually obliged to repay you. Spreading your money between several peer to peer sites is one way of spreading your risk.
Always make sure that you are clear about the charges and fees. The fee structures vary across sites. Zopa lenders, for example, pay a 1% annual fee on the amount they lend to borrowers, which is deducted monthly from their holding account balance, while Rate Setter charges lenders 10% of the interest they receive. Funding Circle charges a 1% fee on all lending.
Start with a small amount and give yourself a few months to see how you get on. That’s the advice from user Daphne Spreull who has money tied up with five peer to peer sites: Zopa, Rate Setter, Funding Circle, Thin Cats and Funding Knight. “The rates of return are good, she says. They are better than you can get with any bank or building society, although the headline rates are now a bit lower – you’re looking at interest rates, after bad debts, of between 4% and 5%.” Spreull, who lives near Manchester, says it is good to give it a few months so you can get used to seeing the repayments come in and how it all works. She says that for a beginner, she would suggest Rate Setter or Zopa.
Also don’t forget about tax, typically, all returns are paid without any tax (even basic rate) deducted, so you should declare your income to HMRC. You need to include interest received from peer to peer lending on your tax return. And there’s some bad news – HMRC says: “An individual lending as part of an investment would need to pay tax on the gross interest income earned. There is no relief for bad debts or platform fees.”