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Peer-to-Peer Lending

Can you really get 6% returns?
Peer to peer lending

Peer-to-peer savings firms like Zopa, Funding Circle and Ratesetter can let you earn a big 6% on your cash.

While it can work well if you're able and willing to lock cash away, it's important you understand the risks of this hybrid form of saving and investing before parting with your cash.

This is a full guide to the best peer-to-peer lenders, running through how it works, how it's regulated, what the risks are, and how the different players stack up.

If you've tried peer-to-peer lending, please let us know if it worked out well for you, and anything extra you think needs adding to the guide .

What is peer-to-peer lending?

Also known as crowd-lending, these websites are industrial-scale online financial matchmakers; money-cupids matching individual borrowers or companies with savers willing to put money aside for longer, hunting for a good return.

As the banking middle-man is cut out, borrowers often get slightly lower rates, while savers get far improved headline rates, with the sites themselves profiting via a fee.

Peer-to-peer looks like saving, tastes like saving, but as there’s no savings safety guarantee, it smells like an investment.

Lending isn't willy-nilly though; borrowers are cherry-picked by credit checks and rated according to risk. These websites do all the repayment chasing on your behalf - so there's no legwork like lending to a fella down the pub.

If it appeals to you, you're debt-free, willing to up the risk and put money away for a longer term, then the best way is to start by dipping your toe in the water. Put a small amount of cash in until you're used to it, remembering that each site works slightly differently.

Savings interest vs peer-to-peer predicted returns
(best pre-tax rates at November 2014)
Easy access 3-year fix 5-year fix
Normal savings 1.4% 2.7% 3.25%
Peer-to-peer websites 2.6% (1) 3.7% (2) 5.9% (3)
(1) via Ratesetter (2) via Zopa (3) via Ratesetter

You pay tax like savings

The interest you earn is subject to income tax in exactly the same way as normal savings. So if you're a basic rate taxpayer you lose 20%, higher rate 40%, top rate 45% off the earnings. You'll be sent an annual interest statement in the same way.

Some people argue that you should also be able to subtract any bad debts from your earnings, reducing the tax bill, but HMRC doesn't allow that. So, quite simply, you pay tax on all the interest you're paid.

This has a specific effect on Funding Circle investors, where the rate you get is before bad debts. So if you go for 8% interest, but after bad debts only receive 5%, you’re still taxed as if you got 8% - this can substantially reduce returns. Funding Circle suggests spreading your cash across at least 100 businesses to sort this.

The government announced in its Autumn Statement in December that it will be changing this element in the tax system of peer-to-peer lending, getting rid of the problem explained above for those that use Funding Circle from April 2015.

You MUST know the risks - peer-to-peer lending isn't for everyone

While for many, it's worked well, returns (and indeed your capital) aren’t guaranteed. The primary risk is, of course, not being repaid.

Each peer-to-peer site has its own way to mitigate this risk, most work well, so that's a crucial factor to consider when choosing a site.

Yet that isn’t the only thing to consider...

  • Peer-to-peer is now regulated

    Consumers using peer-to-peer sites are now better protected after the industry became regulated by the Financial Conduct Authority from 1 April 2014.

  • The new rules state that peer-to-peer firms must present information clearly, be honest about risks and have plans ready in case things go wrong. All peer-to-peer firms must meet these rules or face sanctions, which can include large fines.

    By April 2017 firms will have to have at least £50,000 worth of capital (or more for bigger firm), in reserves to act as a buffer to ensure they can withstand financial shocks or difficulty.

  • Your cash may not be lent straight away.

    No interest is paid while your cash is waiting to be lent out. A few thousand pounds should be lent quickly. But if you're lucky enough to have big cash, say, £50,000 to put in, it can take a number of weeks, so drip-feed it in. There are ways to speed up lending, but it usually involves getting a lower rate.

  • There's no savings safety guarantee.

    With normal UK savings, the Government-backed Financial Services Compensation Scheme promises it'd pay the first £85,000 per person, per financial institution if the institution goes kaput. Peer-to-peer lenders don't have this, even now they're regulated.

  • If a peer-to-peer site goes bust, who'd collect the loans?

    Technically the loans are between you and the recipient, so if the peer-to-peer site goes bust, you’ll still be owed. All trade body members are required to have insurance to pay for a third party collection agency, though if it did happen, things aren’t likely to run anywhere near as smoothly.

  • The unknown unknowns.

    There have been no big horror stories or glaring problems so far. Yet this is a new, innovative industry, so factor in the unknown unknowns, which could potentially blight your cash in an unpredictable way.

Best buys: Which peer-to-peer lender should I use?

The market's developing fast, with lots of new sites popping up. However, there's currently a clear top three that make up the majority of the market and give the best returns.

We've listed them below in order of ease of use, not necessarily returns. The most important difference between the sites is how they mitigate your risks as a lender.

Each site works slightly differently. As with a lot of things in life, the greater the risk, the higher the return.

IF

Longest-running site, Now more similar to savings

Zopa*

  • Current rates: 3.9% for 3yrs, 5.0% for 5yrs after fees and bad debts, before tax

  • Fee: 1% each year of the loan

  • Unlent cash kept in: RBS

  • Min/max lend amount: £10/unlimited

  • Money lent so far: £690m

  • Lenders active: 49,000

The longest-running site, with good rates and risk spreading

The UK's peer-to-peer grandpa, Zopa* was set up in 2005. In 2013 it shifted how it works, so it feels just like putting your money in normal fixed-rate savings. You choose how much cash and how long you want to lock it away for, and you'll get a fixed rate.

Risk mitigation. In the past, its primary risk mitigation system spread your cash in £10 bites amongst many different borrowers. This year it's changed its system, so it's now more similar to smaller site Ratesetter.

Its fund, Safeguard, effectively spreads the impact of bad debts across all its savers. In the background, your money’s spread across a mixed-risk basket of borrowers. Unless there’s a catastrophe, you should get what’s promised.

The rate offered has already had both Zopa’s assumed bad debts (via a contribution to the Safeguard fund) and the fee deducted. If a borrower doesn’t repay, the Safeguard pays lenders what they were due, including interest. The Safeguard fund is then owed the bad debt and uses a third party to try to recover it.

This does dampen the returns a little, as your contribution to Safeguard’s deliberately over-estimated. It currently has £1.2m in it, but the estimated bad debts are £800,000.

If there was an unprecedented number of bad debts, more than during the last financial crisis for example, so the Safeguard couldn’t cover it, each lender would be directly affected by whether their own spread of borrowers repaid or not. Though the third party would still chase the debts for you.

How quickly can you withdraw money? You get monthly repayments. But if you need your capital back before your term ends, its not-that-rapid Rapid Return system takes three to five days to get you the cash. It'll cost you an additional 1% fee.

For over a year-and-a-half, MoneySavingExpert.com founder Martin Lewis has been using all three big peer-to-peer lenders. Here's his experience of Zopa - though of course there are no guarantees...

Find out how Martin fared using Zopa

Ratesetter

Made to look and feel like normal savings for beginners

Ratesetter*

  • Current rates: 2.7% (monthly) 3.6% (1yr) 4.0% (3yr) 5.8% (5yr) after fees and bad debts, before tax

  • Fee: £0

  • Unlent cash kept in: Barclays

  • Min/max lend amount: £10/ unlimited

  • Money lent so far: £423m

  • Lenders active: 17,909

Feels most like 'normal' savings, but lower rates

Ratesetter* is the Rory Bremner of crowd-lending - it's always done a good impression of normal savings accounts. You choose your account and put cash in.

Now Zopa's moved closer to its system, it's easier to compare the two on rates - Ratesetter currently wins over five years. It also allows you to instantly reinvest the interest, so you can benefit from compounding.

One advantage Ratesetter has over Zopa is it's more customisable over rate. For example, if it suggests a market rate of 5% to you – if you wanted your money to be lent out quicker you could go for 4.8%, or if you were willing to wait you could see if it’d be matched at 5.2%.

Risk mitigation. With Ratesetter’s Provision Fund (similar to Zopa's Safeguard), you get a set rate at the time you put money in. You should receive this, unless there are major problems. So far, it’s paid out as promised and the Provision Fund has £1.7 million in it.

How quickly can you withdraw money? Its Sell-Out function allows you to exit contracts immediately. But your rate's reduced, eg, to the monthly access rate, to reflect this.

For over a year-and-a-half MoneySavingExpert.com founder Martin Lewis has been using all three big peer-to-peer lenders. Here's his experience of Ratesetter - though of course there are no guarantees...

Find out how Martin fared using Ratesetter

IF

You lend to companies - generally pays top rates

Funding Circle*

  • Quoted expected return: 7.4% after fees and bad debt, before tax

  • Fee: 1% annual fee + 0.25% if you sell a loan on

  • Unlent cash kept in: Barclays

  • Money lent so far: £457m

  • Min/max lend amount: £20/ unlimited

  • Lenders active: 35,367

Highest rates - but biggest risk of bad debt

Funding Circle* is the purest peer-to-peer system and lends to businesses. The advertised rates are higher, but so are the bad debt provisions, so it's riskiest. The Government's started using it, with £20m put there to fund small businesses.

Risk mitigation. Here, you get a choice. Either:

Bespoke lending: You get each loan proposal and can personally assess each business and whether you want to lend to it. For example, a successful new-build construction firm might want cash to buy equipment so it can expand.

Spread the risk: If you’ve less time, or no clue how to decide, its Autobid system simply spreads your money over a wide range of lenders. So if one fails to repay, it won't hit you too badly. You choose your target interest rate - a higher rate means there's likely to be a bigger risk of some failing to repay.

Funding Circle suggest you spread the risk across at least 100 businesses - even if you pick the firms yourself.

How quickly can you withdraw money? As the loans are repaid, you receive a proportion back every month. In an emergency, for a 0.25% fee, you can trade the debt, and should get your capital back within a day.

Quick questions

Is there tax relief on bad debts?

What checks have been done on borrowers?

For over a year-and-a-half, MoneySavingExpert.com founder Martin Lewis has been using all three big peer-to-peer lenders. Here's his experience of Funding Circle - though of course, there are no guarantees...

Find out how Martin fared using Funding Circle

Alternative sites

All the risks involved in peer-to-peer lending mean it’s sensible to spread your money around different savings and providers, so you’re less exposed to any unpredictable shocks.

Funding Circle, Ratesetter and Zopa aren’t the only peer-to-peer sites, though they’re the biggest. Along with ThinCats, LendInvest, Madiston LendLoanInvest, MarketInvoice, Lending Works*, and Landbay* they’re the only members of the trade association – and so they obey its rules on protection.

Others are springing up all the time, like business lender FundingKnight, Gradurates, which lends to postgraduate students and Assetz Capital's Lend-to-Let, where all its loans are secured on a property, which lowers the risk and the rate too.

We would love your feedback on your experiences of using peer-to-peer lending sites.

Glossary

Glossary