Peer-to-Peer lending is becoming an increasingly popular option for savers and investors looking to get more from their money. With low interest rates and rising inflation, it is no surprise that peer-to-peer lending (P2P) has grown so significantly over the last few years.
If you are considering P2P lending as an investment option for your money, it is important to understand both the benefits and risks of this relatively new asset class. Only then, can you to make an informed decision as to whether P2P is right for you. In order to give you a fuller picture, we’ve outlined some of the key advantages and disadvantages of P2P lending.
What is P2P Lending?
P2P lending, also referred to as direct lending, is over 10 years old. It is however only in the last few years that it has become recognised as a mainstream asset class. Simplistically put P2P lending brings together investors (you) with borrowers (this could be an individual or a business) via an online lending platform. Platforms can offer potentially higher returns because of lower operating costs (there are none of the costs associated with bricks and mortar branches) and by deducting fees from the loan repayments made.
So, what are the ‘Pros’ of P2P lending?
Access to higher returns: P2P can potentially give you access to significantly higher returns than you could get through a high-street savings account.
Risk diversification: P2P platforms let you spread your capital across multiple loans1. This enables you to better manage your exposure to risk. For example if £5000 spread over 100 loans and one of those loans defaulted your potential loss is £50. Whereas if you spread the same £5,000 over just 10 loans and one defaulted then your potential loss is £500.
Choice: You can choose who you want to lend to. For example, you can decide you only want to lend to borrowers who have an asset such as property or a business as security.
Personal Savings Allowance: Any interest you earn through peer-to-peer lending is now included in your ‘Personal Savings Allowance’. This currently stands at £1,000 interest for individuals paying basic-rate tax and £500 for higher rate payers.
Access to your money at short notice: Many P2P lenders let you liquidate your funds before the loan ends if you need, as long as they can sell that loan position on. You will of course need to check this with the individual platform. For example, on average, BondMason clients have been able to fully liquidate their positions in full within 24-48 hours.
And the ‘Cons’ of P2P lending?
Your money is at risk: Probably the most important risk you need to understand is that, unlike mainstream banks, your money is not covered by the Financial Services Compensation Scheme (FSCS) – which currently compensates you up to £85,000. Therefore, if you decide to deploy your capital through a P2P platform, choosing your platform carefully is essential. Make sure they are clear and upfront about the risks involved and any plans they have in place in the event something goes wrong.
Interest is not tax free: With the exception of your Personal Savings Allowance, any interest you earn will be taxed and you will need to declare any interest earned on your annual tax return.
Your cash may not be lent immediately: Whilst you are waiting for your cash to be lent it won’t be earning any interest. However, most P2P platforms will be as eager as you are to get your cash deployed. In fact, even if your money is slower to get lent out, the overall effect on your return is likely to be minimal in the long term.
Time constraints: There can be a thing as too much choice. Because of the wide range loan choices (some of which are complicated) and considerations, managing a diverse portfolio can be time consuming. You may want to think about using a managed direct lending platform as an alternative or as an addition. These are more ‘fund and forget’ models where experienced investment teams select the loans and diversify for you.
What about P2P regulation?
Regulation of the UK P2P lending industry is rather more complex, which is why we haven’t added it into our ‘Pros’ columns.
As an industry, Peer-to-Peer welcomes regulation – anything that protects the consumer can only be positive. It is however imperative to remember that FCA regulation does not in itself guarantee the quality of a platform. It is important not to assume that just because a platform carries an FCA logo that your capital is safe.
When choosing a Peer-to-Peer lending platform, even if that platform has FCA regulation, the key two things to check are:
- The investment experience of the team behind the platform. It is important that the platform has a strong financial background – the more experience the better. This way you know that they are going to be making informed and sensible choices about originating and managing loans as well as being able to identify loans and lenders to avoid.
- Are the platforms aligned with to your interests? For example, do they invest in the loans alongside you?
Direct Lending is growing and becoming far more mainstream and can be an excellent way to access higher returns. However, in order to decide whether is the right option for you, it is important that you do your research and take the time to understand the risks associated with P2P.
*Warning: nothing in this article should be construed as advice. Your capital is at risk
1 Some managed direct lending platforms will enable you to spread your capital across multiple platforms as well as multiple loans – further diversifying risk.
Free Peer-to-Peer Lending Guide
This article provides a brief overview of the advantages and disadvantages P2P. If you would like to find out about P2P lending in more detail then our FREE P2P Lending Guide offers a comprehensive, informed, and impartial guide to everything you need to know about getting started with direct lending.