If you’re fed up with low interest rates on your savings, you might consider a peer-to-peer lender instead. The idea is that you lend money to people or businesses through an online platform. In return, you’re paid interest. But it can be riskier and your money is not protected if the site goes bust and there’s a shortfall.
What are peer-to-peer lenders?
Peer-to-peer lenders work by matching potential borrowers, who want a loan (which may be individuals or businesses), with lenders, who have cash to lend out. Normally any money you lend is split up and lent out to a number of different borrowers, which should reduce your risk.
SAVVY TIP: Peer-to-peer lenders now lend to individuals (Zopa and Ratesetter are two firms that do this), limited companies and sole traders. Funding Circle lends to businesses, including sole traders and partnerships.
How many different peer-to-peer lenders are there?
The number of sites is growing. The biggest and original peer-to-peer lender in the UK is Zopa.
Other peer-to-peer lending sites include Ratesetter and Funding Circle, there are sites such AssetzCapital and Funding Knight – to name just a few. However, it’s worth knowing that, as I write this, not all are members of the industry’s association, called the Peer-to-Peer Finance Association.
How do you register to use a peer-to-peer lender?
It’s normally fairly straightforward to sign up online. However, you will have to go through the usual money laundering checks. Once you’ve registered:
– You can transfer a lump sum or a regular payment into your account. Most people tend to start off with a small amount and either add to it regularly or lend out a larger amount once they’re more comfortable with the process.
– Borrowers’ details will be checked. Peer-to-peer lenders say they carry out detailed checks before they match lenders and borrowers. The checks will involve looking at someone’s credit file and carrying out a credit score.
SAVVY TIP: The process and the number of checks carried out vary from one lender to another. For example, Zopa, the biggest peer-to-peer lender, checks credit reference files, will contact a borrower’s employer to check that they do the job they say they do at the salary they’ve stated and will look at how much they can afford. Zopa says it turns down as many borrowers because they can’t afford the loan as those who don’t have a good enough credit history. Ratesetter also turns down a large percentage of those who apply.
– Borrowers are ranked according to their risk. The lower the risk, the lower the rate someone can borrow at and therefore the lower the return to the saver. For each category you’ll normally get an idea of the interest rate that people are being lent to. You can lend at whatever rate you want to, but if you lend at a higher rate you may not find many takers.
SAVVY TIP: Different websites have different ways of categorising borrowers. If you are thinking of lending money you should also be given information about the bad debt rate for a particular category. Funding Circle’s bad debt rate is currently 1.5%. Zopa says its rate is 0.8%.
– Borrowers and lenders are matched. The loan requests can be matched by the website or individual lenders can bid to lend to borrowers.
Factors affecting your return
Most lenders spread their money around between different types of borrowers, charging different rates and for different terms.
– Find out how much you will be charged. You’ll be charged a fee by the peer-to-peer lender for placing your loans but the rate of return that’s quoted should be after fees and charges have been deducted. For example, Zopa charges a fee of 1% on money that you’ve lent out. It’s taken from your account every month. Ratesetter charges 10% of the interest you’ve received and Funding Circle charges 1% of the amount you’ve lent out plus 0.25% if you sell a loan on.
– Check your exposure. It’s definitely worth checking how your money will be parcelled up and finding out what the maximum amount is that you can lend to any one individual.
– Keep track of your money. You should be kept updated regularly with information about how much you’ve lent out and you’re overall rate of return.
– Your return can change. Even if you agree to lend out money at a specific rate of interest, you may not receive that return. If someone repays their loan early, they’re late with a payment or don’t pay at all, your rate of return will fall.
SAVVY TIP: Be aware that some social lending sites offer much higher returns than others, but if the rate is unsustainable you won’t benefit. Check their default rate. It should be low (preferably less than 1.5% on average).
– You can access your money early. If you don’t want to leave your money lent out for the original term you can normally sell that part onto other lenders. However, it’s not instant (it can take a couple of days), you’re reliant on demand and there’s usually a fee to pay as well.
– Don’t forget about tax. Like bank savings, interest that you earn by lending out money on a peer-to-peer site is taxable. Tax isn’t generally deducted by the peer-to-peer lender, so you will have to tell HM Revenue and Customs about the interest you’ve received unless you’re a non-taxpayer. Fees that you pay are tax deductible.
SAVVY TIP: From April 2016, people who lend out money through a peer-to-peer website won’t have to pay tax on losses (which up until then they had to do).
Is your money protected?
First things first, money that you lend isn’t protected by the UK savings compensation scheme (the Financial Services Compensation), in the same way that bank and building society savings are. That means if the lender goes bust and there’s a shortfall of money you may not get all your money back. Likewise, if any of the people or businesses you lend to default, you won’t get your loan paid.
Companies that have joined the association have to have certain levels of capital (cash, effectively) behind them and must keep individuals’ funds separate.
– The peer-to-peer lender may have its own contingency fund. Some sites, such as Ratesetter, have a contingency fund to cover bad debts. Zopa has something called ‘Safeguard’. This basically aims to pay back all your money if a borrower defaults. It’s not a cast iron guarantee, but Zopa says it currently has more money in the Safeguard fund than it needs to cover estimated defaults. However, not all Zopa savers like it as it has reduced returns and some complain about the lack of control. Check what the site you’re thinking of lending through offers if you’re concerned.
SAVVY TIP: Since April 2014 peer-to-peer lenders have been regulated by the Financial Conduct Authority (FCA), so you can complain to the Financial Ombudsman Service if you have a complaint that can’t be resolved directly with the company.
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