Lend your savings to businesses or individuals to get a better rate of interest on your money than you would through a conventional bank or building society savings account.
Peer-to-peer lending is not regulated by The Financial Services Authority.
What is Peer-to-Peer-Lending?
Peer-to-Peer lending, also known as crowd lending, is a hybrid form of saving and investment, bringing together individual borrowers, entrepreneurs or companies with savers willing to invest in long term projects.
As Peer-to-Peer-lending is run by online financial matchmakers utilizing websites as main exchange platforms, banks and building societies are not involved in these transactions. Such platforms profit from offering this service with a fee, borrowers commonly get lower rates while savers are attracted with fairly high rates. As UK Net Guide features some providers above, Funding Circle and Wellesley and Co.
How does Peer-to-Peer-Lending work?
In order to prevent fraud or failed investments, borrowers are pre-selected by background- and credit checks and then rated according to risk. Unlike with conventional lenders, the websites take care of the repayment, so that lenders do not immediately have to become active as a result of default.
All interest that you earn with Peer-to-Peer lending is subject to income tax just as normal savings, with a basic rate taxpayer looking at 20%, higher rate taxpayer at 40% and top rate taxpayer at 45% of the earnings.
When making your investment, you get to choose which type of borrower you want to lend your money to. You can choose from the risk-ratings given on the website, bearing in mind that the higher the risk of the borrower, the higher the interest that can be charged, but this also implies a higher risk of losing your money. Some websites also present the specific projects that borrowers need the money for.
Peer-to-Peer lending-websites profit from both, borrowers and investors. You normally have to pay a fee, which can be either an initial fee, such as a percentage of the amount you lend, or a percentage of the amount of interest that you receive later on.
In case you want to terminate your investment early, you might be charged a fee. Sometimes Peer-to-Peer websites may offer you to sell your loan to another lender, but also here will most likely be a transfer fee. In addition, if your borrower has defaulted on a single payment, you cannot transfer your loan to anyone else.
Drawbacks of Peer-to-Peer Lending
The core risk of this type of investment is that you run the risk of not being repaid. While in the case of a savings account, losses of borrowers not paying back their loans are absorbed by the financial institute, in the case of Peer-to-Peer lending, it is the lender who has to absorb the loss. Hence you have the chance to earn higher return rates, as you are taking a higher risk because you can potentially lose your money.
In order to mitigate risk, Peer-to-Peer lending is now regulated to by the Financial Conduct Authority (FCA) since April 2014 in order to ensure better protection to the lenders, even though not to the same degree as banks and building societies. This entails obligatory rules such as companies stating all information clearly, transparency in presenting all risks involved and a financial insurance.
This entails Peer-to-Peer lenders keeping client funds and repayments in a third account. They furthermore must have a set level of capital to sustain potential financial shocks.
Furthermore, borrowers who change their minds about an investment can withdraw within 14 days if they have not spend the money. Additionally, the FCA introduces rules that allow investors to complain.
Peer-to-Peer lending is a type of investment, as compared to a savings account where you can access it if you need to. While you do have certain opportunities to access your funds, you should refrain of investing money that you might need back quickly.
Despite these regulations there is no savings guarantee given by the Financial Services Compensation Scheme. If a Peer-to-Peer site crashes for whichever reason, the lender is still owed and until now, the process of reimbursement has not always gone smoothly.
Another drawback is the fact that depending on the size of the sum, the money and in particular large sums are not always lent out directly, and depending on the provider, it can take days or week. Hence it is sensible to put in smaller sums, rather than a lump sum to speed up the process.
Peer-to-Peer lending is still a new and somewhat undiscovered industry. While this is part of its appeal, it means that some issues can still come up unexpectedly.
Tips for choosing Peer-to-Peer Lending
Peer-to-Peer lending is a new and innovative field that offers many interesting new opportunities.
Before you choose to make a large investment, it is always the safest bet to start by diversifying your risk and putting small amounts of cash in, taking into account that all different websites have different strategies of operation as well as terms and conditions.
In most cases you can start investing with as little as £10 in order to try different Peer-to-Peer lenders and reduce your risk.