Peer to peer lending is a financial product where borrowers and lenders are matched together. The borrower pays an interest rate to borrow money, while the lender receives an interest payment, minus a commission fee from the peer to peer lending site.
While you can potentially receive higher interest rates from a peer to peer lending site if you are a lender, there is the risk that you may lose some or all of your money.
Peer to peer lending is on the rise – read our guide to learn more about it and companies like Zopa. Lending out your savings to your peers might not seem like an obvious way of investing, but social lending is becoming increasingly popular.
Peer-to-peer platforms, such as Zopa have been offering rates on loans for individuals and businesses at competitive rates. While offering savers a boost on their investment that many banks are struggling to compete with. Read on to find out how social lending sites work, and why they could be a good investment for your money, and also the potential pitfalls.
Zopa and other social lending sites are based on a community of people who lend and borrow money between themselves, rather than going to banks and building societies to get a savings account or a loan.
Social lending can be a win-win solution for lenders and borrowers, who may both be able to find better rates than they might get elsewhere. However, they also come with their own set of problems through added risk.
Like all investments, social lending does have an element of risk. Investing in Zopa isn't like putting your money into a savings account – there's no 100% guarantee that you will get your original investment back. As always, the opportunity for a higher return on your money goes hand in hand with greater risk.
Peer to peer lenders are now regulated by the Financial Conduct Authority, but the money you invest in a peer to peer loan, will not have the savings protection that bank and savings accounts enjoy.
Also the regulator introduced new rules to ensure that investors don't put too much of their money into peer to peer (P2P) or social lending. As well as limiting the exposure an individual can have to 10% of their investible assets.
This was because the regulator was worried that individuals might be exposing their savings to a greater risk and that some were not fully aware of the pitfalls involved in social lending.
While this new protection came into force in December 2019, it didn't include any government protection for your money that you invest in a peer to peer lending product.
While the government’s Financial Services Compensation Scheme (FSCS) protects up to £85,000 of money held in each savings account with a banks and building society, this isn't the case with social lending.
This means that if you're an investor in peer to peer lending and a borrower defaults on their payment, you're not fully protected.
Increasingly, peer-to-peer platforms are creating their own 'safety net' funds to ensure that customers get their money back in such an event. So be sure to check what measures the site you use has against lending risks.
Many sites ensure that potential borrowers are credit checked and risk-assessed before you can lend to them.
The money you lend is spread across a number of borrowers to minimise the risk of bad debt, so for example if you were to lend over £1000, your money could be spread across 100 different borrowers.
Zopa also has protection in place for your money in the unlikely event that it were to go out of business – Zopa is not involved in the contracts you have with borrowers, so they remain legally binding and repayments still have to be made.
You invest at least the minimum deposit and decide between high or low risk lending.
You can also decide who you want to lend to - you pick the type of borrower you are happy with, based on their level of risk as assessed by Zopa. Zopa then matches offers of lending to requests from borrowers and oversees the loan agreement and repayments for you.
You will have to pay a fee for the service as well, so it's worth adding up your total costs. Then weighing up the risk when comparing a peer-to-peer platform to a regular savings bank account
If you're lending to retail customers, then they may be applying for a Zopa personal loan, or Zopa car loan. The credit checking process aims to identify any borrowers who might have bad credit.
If you're looking for a better return on your money than a savings account, you could opt to invest your money in an Individual Savings Account (ISA) instead.
If you're looking to borrow money, then other options might be using your bank overdraft, borrowing on your credit card, or taking out a personal loan. You can find out more about personal loans and how they work by reading our guide to personal loans.
Whichever option you choose, it's important to have a repayment plan in place. So that you either pay off the borrowing gradually, or you have a plan to clear your debt at the end of the term of the loan.
The future for personal borrowing is quite uncertain given the COVID-19 crisis, and it's not clear how loan and borrowing rates will be affected over the coming months.
Some of the deals that are available now may be changed or withdrawn. Therefore, if you can, reducing or clearing your debt could be a helpful way to ensure your finances are in the best state they can be going forward.
If you're deciding between peer to peer loans, personal loans and debt consolidation loans, take a look at our comparison tool.