Peer-to-Peer Lending

With normal UK savings, the Financial Services Compensation Scheme offers you a level of protection. It promises to pay the first £85,000 of any money saved per person, per financial institution if that institution went kaput. Any money you've invested with a P2P lender that's being loaned out doesn't have this, even now lenders are regulated.

And while for many people P2P lending has worked out well, with a good rate of return, we don't know what the future holds.

And while P2P firms have to give you clear and honest information about the risks of the lending that they do, and their plans for when things go wrong (and also need to have at least £50,000 of capital for if things go wrong), we must caution you – and we'll say it in big letters:

Regulator the Financial Conduct Authority launched a set of tighter rules for P2P lenders in 2019. The headline one was that new investors are no longer allowed to put more than 10% of their 'investable assets' into P2P (an investable asset is essentially spare cash, so doesn't include things like your home or car – though a second home would be counted towards your total investible asset worth).

You'll need to 'self-certify' by telling the provider you won't invest more than this.

However, this 10% limit won't apply to all. For example, if you've received financial advice, you'll be able to invest more. Plus if you're an experienced investor (the platform will ask you a series of questions each year to check this) you also won't be bound by the limit.

Our view is that while this 10% rule is only for new investors, it's an important signal about not overexposing yourself to the risks – see Martin's warning above.

The 'innovative finance ISA' (IFISA) allows P2P investors to lend out up to the annual £20,000 ISA allowance within an ISA wrapper, so interest on that portion of money will be tax-free forever. The two providers we mention as top picks in this guide both offer IFISAs to new and existing customers.

However, if you prefer to use your ISA allowance for a cash ISA or a stocks & shares ISA, you can just lend through these sites outside of the ISA wrapper. You'll pay tax on the interest, unless it's covered by your personal savings allowance.

Accessing your cash usually depends on there being new investors you can sell your loans to. While this can work well in good times, we saw 1,000s of people trying to access their cash at the start of the pandemic – but there were very few new investors to buy the loans. This led to queues lasting months.

So be aware that while you can access your cash, it may not be instant – and it could even take months.

There's also a question of how this secondary market would work if interest rates were to rise. If, say, you're lending out at 4% and want to exit, but newcomers can lend out at 9%, how easy will it be in practice to get someone to actually take over your loans?

The P2P platforms in this guide quote 'expected', 'projected' or 'target' returns for investors.

But, in practice, the actual rate you get could be less. For example, we saw larger numbers of borrowers than usual defaulting on loans during the pandemic, which hit investors' returns.

No interest is paid while your cash is waiting to be lent out.

Usually this doesn't matter, as it only takes a few days for your cash to be lent out. But, since the start of the pandemic, we've seen it take up to a couple of months for cash to be lent out.

There's often little you can do to speed this up, so you'll need to be prepared to accept that your money won't be working for you for the first couple of weeks or months.

This is especially pertinent if you're lending a lot in one go. It's best to dripfeed money into the platform £10s or £100s at a time.

Technically the loans are between you and the borrower, so if the P2P site went bust, you'd still be owed. All P2P firms need to have plans in place for an 'orderly wind-down' of the business. This could include having insurance to pay for a third party to collect outstanding loans, though if this did happen, things aren't likely to run anywhere near as smoothly.

An example of this was investors in collapsed firm Lendy waiting to see if they'll get back their share of the £150 million invested.

There have been horror stories in the US and with some providers in the UK, including the May 2019 collapse of mid-sized firm Lendy. This is a fast-changing industry and you have to factor in the unknown unknowns.

While some firms came through the pandemic, others didn't. And even the ones that came through saw their business change overnight – more borrowers defaulted and more lenders wanted to get their money back as they needed to use their savings. Loan rates went up, but so did bad debt provisions, so the 'target' interest rates for investors actually went down.

Other things will happen in the future that we can't predict, so you need to consider if you're willing to take this risk with your money.

Yes, the interest you earn from P2P lending is covered by the personal savings allowance – despite the fact they're not 'savings' in the traditional sense. So basic-rate taxpayers can earn up to £1,000 in interest (in total, from P2P lending and savings combined) per tax year and higher-rate taxpayers can earn up to £500. Additional-rate taxpayers don't get a personal savings allowance.

Any interest you earn that exceeds the allowance will be subject to tax. For more info, see our Personal Savings Allowance guide.

Following the introduction of enhanced Financial Conduct Authority (FCA) rules in the sector, previous self-regulatory body the Peer-to-Peer Finance Association has been disbanded. A new group, 36H (named to reflect that members are fully authorised by the FCA under article 36H of the Financial Services and Markets Act 2000), has been set up in its place to be a voice for the industry.

Membership is open to all lending platforms that are authorised and regulated by the FCA under article 36H legislation. The group says it will "focus on policy and regulatory matters, as well as promoting the benefits the sector is delivering; including bringing choice, competition and transparency to the lending and investment markets".