Peer-to-peer or social lending has gradually become more popular in Britain since it started to make an appearance around ten years ago. The idea is to give individuals or businesses an alternative method of borrowing or lending money without the involvement of a bank.
For example, if a person wanted to take out a loan they could go to a peer-to-peer lending website and fill out an application. Once the loan is accepted, the amount would be matched across all available lenders who are looking to invest their money.
One of the key benefits of peer-to-peer lending is the attractive rates; borrowers pay less interest on a loan than they would at a bank and lenders receive a much higher return than they would using a regular savings account.
There are several companies that offer these services, such as Funding Circle, RateSetter and Lending Works, but I chose to use Zopa as it is the largest site with over 60,000 active individual investors and 277,000 borrowers.
Since launching in 2005, Zopa has lent out over £2.56 billion to consumers, with £800 million of that sum lent out over the last 12 months.
Pros and Cons of Zopa
Lower interest rates for borrowers and higher returns for lenders than you would get using a traditional financial institution. From an investor’s point of view, the average annual return is 3.9% for their “Core” product and 6.1% for “Plus”.
Fast cash out - If you need access to your money before the end of the loan term, you can sell your loans on to other investors for a 1% fee.
Trusted company - Zopa has been running since 2005 and is the largest peer-to-peer lending platform in the UK. The company has a good track record with staying afloat in the face of economic uncertainty, surviving the banking crisis in 2008. Despite a temporary rise in default rates, lenders still received a positive return throughout the recession.
Risk diversification – When investing with Zopa, your capital is split across multiple loans which lowers the level of risk significantly. For example, my £1000 investment has been spread across 110 loans, which means if one defaulted I would only be facing a loss of around £9.00.
It’s not risk free – Peer to peer lending is not covered by the FSCS, which means that your capital is at risk if there is a high default rate on your loans. Zopa include the expected default rate when calculating the average annual return on your investment.
This is based on past performance, so there is no guarantee that it will be the same in the future. On the upside, if default rates are lower than predicted the returns will be higher.
Your money is tied up for a minimum of 36 months, however there is the option to cash out loans on Zopa for a fee of 1%. Alternatively, you can opt out of reinvesting your funds into new loans and your money will gradually return to your holding account.
There are some horror stories around when it comes to peer-to-peer lending, for example the Guardian recently reported (click here) that a man was left £12 down from his £1000 investment into Funding Circle, after investing over a period of 18 months. This was the result of investing 10% of his fund in one loan, which meant that when the firm he lent to defaulted he was left with a significant loss, wiping out any interest he had accrued from other loans.
Risking that much on one loan is generally a bad idea and I feel comfortable knowing that my investment in Zopa is split by less than 1% per loan.
Alternative Peer-to-Peer Lending Platforms
RateSetter – RateSetter is another p2p company based in the UK that established in 2010 and has matched over $2 billion in loans. They have a higher default rate in comparison to Zopa at 0.51% versus 0.02%, but are still regarded as one of the safest options for p2p lending in the UK.
Lending Works – Lending Works has been running since 2014 and claims that it is safer than its rivals due to carrying out credit checks using Equifax and the Lending Works Shield. The Shield is basically an insurance policy to cover default rates of more than 10% or economic downturns and a reserve fund to compensate lenders.
The added security comes at a price though, so interest rates are slightly lower in comparison to Zopa and RateSetter.
Funding Circle – Funding Circle launched in 2010 and they specialise in peer-to-peer lending to businesses rather than individuals. The investment can be allocated across 100+ business loans to lower the risk, or alternatively you can manually select which businesses you want to invest in.
There is of course a higher risk of losing money when lending to businesses, but the returns can be much higher. The projected annual return for 2017 has been calculated at 7.1% after taking into bad debt and fees into account, which is almost double the projected return from Zopa’s Core product.
There are a range of options for investing in peer-to-peer lending, but it all comes down to how much of a risk you want to take and what kind of returns you are looking for. There is one thing for sure though, it beats leaving your money in the bank!