With interest rates at an all-time low and inflation set to rise, 2017 is looking like yet another challenging year for savers. Peer-to-peer lending can offer an alternative way to target a higher return from your money. So, what exactly is P2P lending and how is it different to traditional savings options?
2016 wasn’t the greatest year for savers. Interest rates plummeted to a historical low and inflation rose to its highest level in two years. The average savings account in a traditional bank or building society is now so low that, coupled with rising inflation, some cash is actually losing value in real terms.
P2P Lending can offer attractive rates of return
As savers seek out better returns for their cash, we have seen a rise in the popularity of P2P lending with average return rates ranging between 3-12%; significantly higher than most high-street savings accounts. Peer-to-Peer lending, also referred to as marketing place lending or direct lending, appeals to savers who want to earn a better return on their cash but avoid the dramatic rise and falls associated with stocks and shares.
Interest earnt from P2P lending is also included in the new Personal Savings Allowance which means that basic-rate tax payers can earn up to £1,000 interest without paying tax on it and higher rate tax payer up to £500.
Peer-to-peer investing is becoming more mainstream however, compared to other more traditional savings and investment options, in terms of visibility in the UK, it is still a relatively new entrant to the market. You may not therefore, be familiar with exactly what P2P lending is or fully appreciate the risks. Understanding both will help you make an informed decision and make the most out of all direct lending has to offer.
What is Peer-to-Peer (P2P) lending
Briefly, P2P lending brings together individual borrowers or businesses with savers and investors who are willing to loan their money to them. The Bank, who is essentially the middle man, is cut out. Online Peer-to-Peer platforms facilitate this process for a small fee (usually between 1-2%).
Savers and investors can benefit from a better return rate than would be possible through a traditional bank or building society savings account, and borrowers benefit from lower rates than if they took out a loan through a bank.
What you should consider before getting started with P2P lending
How safe is P2P lending?
Like most investment options there are risks associated with P2P lending and it is important you fully understand those risks and the most effective ways to manage them. Only then can you decide whether P2P lending is for you. The following are some of the key risks associated with P2P lending that you should be aware of:
- Your money is not protected by the FSCS: The first thing to be aware of is that unlike traditional bank or building society savings accounts, your money is not protected by the Financial Services Compensation Scheme (FSCS). For example, if your money is in a financial institution such as a bank or building society and it goes belly-up, up to £85,000 of your money is protected. Peer-to-Peer lenders are not included in this so you would not receive this protection if the P2P platform your money was in collapsed.
- Interest isn’t paid on money waiting to be lent: Although direct lending platforms do their best to get your money lent quickly, if you have a large amount to invest you may have to wait awhile before it is all lent out, whilst your money is waiting it’s not earning any interest.
- Risk of bad debt (your capital is at risk): Like all loans, there is a risk that the borrower may not be able to make repayment. Unless the borrower has offered security against the loan it may be possible not to get some, or all, of your money back if the loan defaults.
How can I minimise P2P lending risks?
If you are considering investing in P2P lending there are steps you can take that can help you mitigate risk.
- Don’t put all your eggs in one basket: Spreading risk by diversifying your money across a number of different loans, borrowers and platforms, is one of the most sensible ways to minimise the impact of any losses. For example, if you invested £5,000 across 100 loans and one of those loans defaulted, your potential loss on that loan would be up to £50. On the other hand, if your loan was spread against just 20 loans and one defaulted then your potential loss could be nearer £250.
- Consider asset-backed lending: Asset backed lending is where a loan is secured against an asset. So, if a borrower can’t make their repayments then all or some losses may be recovered. This gives you a bit of added security should a loan default.
- Choose your platform (s) carefully: Spend time researching the market. Whilst there are some excellent lending platforms out there, there are also some that aren’t so great and that you may want to avoid. This is the most important consideration prior to starting to invest in P2P Lending.
What should I look for when choosing a P2P lending platform?
Ideally, you want a platform(s) with a good balance of risk and return. So, when investigating the P2P lending platforms on the market, you may want to consider the following:
- Who are they and how much financial experience do they have? Take a look at the team running the platform. A good platform will have a team with a solid financial background. An experienced team will spend time selecting loans and can confidently understand and assess levels of risk.
- What information do they publish on their website? How transparent is the lending platform - does it provide information about its record as a lender? For example, does it publish its default rate?
- How quickly can you access your money? You may also want to consider how quickly you may want to liquidate your funds. Make sure you check out different tie-in periods
- Who are the borrowers? You need to feel comfortable about the type of borrower you are lending your money to, whether its consumers, small business or property. As mentioned earlier, it is also important to know whether that lending is secured or unsecured.
If you are new to P2P lending, then you may want to consider manged P2P lending. Handling the whole P2P lending process yourself can be time consuming and involves a significant amount of work. A managed, multi-platform system will ensure the diversification you need by spreading funds across multiple platforms and loans, and will automatically re-invest repaid money into new loans. Remember, the same selection rules apply when choosing this type of lending platform as well.
P2P Lending can be a great alternative investment option to make your money work harder, particularly at a time savers are suffering from low interest coupled with increasing inflation. Understanding Peer-to-Peer lending, and appreciating how to best manage any risks, will enable you to make a confident and informed decision about the best place for your money.
*Warning: nothing in this article should be construed as advice. Your capital is at risk
For further information download our FREE, impartial guide to P2P Investing
This article provides a brief overview of P2P lending. However, if you would like to find out about P2P lending in a bit 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.