What exactly is peer-to-peer lending? How do peer-to-peer loans and savings actually work and is peer-to-peer lending safe?
Peer-to-peer lending matches people who want to borrow money with people who have money to lend. As a peer-to-peer lender, you can potentially earn higher rates of interest compared with the rate you would get from high street banks. As a borrower, you might find a peer-to-peer lender who would consider you when a bank or building society might turn you down.
Peer-to-peer (P2P) lending in the UK has become more popular and widespread in recent years. But Covid-19 has affected P2P loans and lenders have adjusted their policies to accommodate the greater risk. So how safe is a peer-to-peer investment, and is it suitable for you?
Read our guide to learn more about peer-to-peer lending companies and if the savings and loans can work for you.
Peer-to-peer lending is a very different product to a savings account and carries greater risk. If you put your money in a savings account with a bank or building society you could earn a rate of interest in return with very little risk to your capital. However, currently savings rates with traditional lenders are very low. With a regulated bank or building society, your money is protected by the Financial Services Compensation Scheme (FSCS) up to the value of £85,000 per account, which means that if the bank were to collapse, the government would step in to compensate you and your cash would be protected. This is not the case with peer-to-peer lending. It is not covered by the FSCS.
Covid-19 has created a very uncertain economic climate and has affected the availability of peer-to-peer lending funds.
Although the furlough scheme has been extended, it is not clear how the jobs market, lending and the economy will be affected. Therefore, it is not possible to predict what will happen to peer-to-peer lending if a recession were to hit after government financial support for businesses is withdrawn.
Peer-to-peer lenders have tried to reduce the risk of borrowers defaulting on their payments, but the risk remains.
There have been reports of people who invested in peer-to-peer schemes having to wait many weeks or months to get their money back after they gave notice that they wanted to withdraw from the scheme.
What’s more, rates, which were as high as 6%, have fallen since March 2020 and although borrowers still pay high rates, the increases are not always passed on to the individual lender.
Peer-to-peer lending is much riskier than a simple savings account, and should only be used for money you can afford to lose. Even then, you may take the view that the future is so uncertain that this type of lending carries too high a risk in the short term.
However, peer-to-peer lending pays a much higher rate of interest which is why some lenders find it an attractive product. The websites that offer peer-to-peer lending match the lenders and borrowers at higher rates of interest than the banks, while taking a commission for setting up the deal.
The biggest peer-to-peer lending sites in the UK are Zopa, RateSetter and Funding Circle. There are also some smaller and less well-known companies. Some lenders have cut their rates recently because of economic uncertainty.
RateSetter says investors are matched with borrowers in a live market. Money is matched up on the RateSetter platform. When a new investor comes in with money to lend, this money goes into a queue to get matched with new loans as well as existing loans of investors who wish to release their investment.
RateSetter currently says (at January 2021) that early access to your money is not guaranteed if you want to withdraw early. Its Covid-19 update at January 21, 2021 says:
“Following the start of the Covid-19 outbreak in the UK, we saw an increase in investment release requests, peaking on 16th March and then falling back to normal levels over subsequent weeks. We have delivered £249 million of release requests since the start of the outbreak. Processing of release requests in Access, Plus and Max and the 5-Year market is up to date.”
With peer-to-peer lending, when you want to take your money out, you usually have to find another buyer for your loan. Covid-19 has made that more difficult to arrange as more investors have withdrawn from the market.
RateSetter says on its website that: “In an extreme scenario you may have to wait for borrower repayments. During this time, your money will still be earning interest.”
Funding Circle is offering investors a projected annualised return of 4.5 - 6.5%.
If you make an investment and later decide to withdraw a lump sum, Funding Circle says you need to select the amount you’d like to withdraw and sell your active loans to other investors using the automatic selling tool.
It explains: “When a loan part is sold, a 1.25% transfer payment is paid to the buyer by the seller. For example, a £20 loan part is sold for £19.75. The time it takes to sell may vary as it depends on demand from other investors looking to buy at the time. You can only sell active loans with no credit issues, and not in the last month of their term.”
In a statement in July 2020, Funding Circle explained that it had taken a number of steps to protect investors’ money. These were:
Tightened credit risk parameters
Enhanced risk monitoring
Strengthened collections and recoveries capabilities
Zopa is currently suggesting that investors could generate projected returns between 2.0% - 5.3%. It currently has a waiting list for new investors.
Although Zopa is regulated by the Financial Conduct Authority (FCA), the money watchdog, it is not part of the Financial Services Compensation Scheme.
Zopa says: “In line with FCA guidance released in March, we have been offering payment freezes or reduced payment plans to borrowers impacted by the Coronavirus. These arrangements can last up to six months.”
For investors, this might mean that they do not receive any interest payments for a while.
As Zopa explains: “While on a payment plan or a freeze due to the disruption caused by the pandemic, the loans will not default. This provides the right support and incentive for borrowers to go back to repaying their loans on the original terms once things recover, making it less likely that you'll lose the value of the loan from your investment balance. However, this does mean there will be a pause or reduction in payments on loans while they’re on a freeze or reduced payment plan.”
By lending your money on a P2P lending site you could enjoy access to higher rates, but there is also the risk that you might lose all your money. It is a balance between risk and reward. Savings rates on traditional bank accounts are very low at the moment, which has led investors to look elsewhere for a better return on their cash.
Compare a number of peer-to-peer and other personal loans on our comparison table.
Peer-to-peer lending sites like Zopa and Funding Circle act as the administrators, helping you find people to peer-to-peer borrow from, or those who you can offer peer-to-peer loans to.
By cutting out the banks those looking to lend are able to get slightly lower rates whilst those looking to save money by lending should get a slightly improved rate.
Peer-to-peer lending sites are therefore growing in popularity for both savers and those looking to lend, but it's important to remember that they're not savings accounts.
There is a big difference between having your cash in a savings account and lending via a P2P platform. A P2P lending scheme is not covered by the Financial Services Compensation Scheme.
Those borrowing money are credit-checked and receive a risk rating that informs at what rate they can borrow, similar to a bank.
If you run into trouble recovering a loan the websites act on your behalf.
You can potentially earn much higher than average interest rates.
You may not get the headline rate of interest advertised
You may not get your money back if the borrower does not pay or the lending website goes bust
Although P2P firms are now regulated, your money is not covered by the FSCS and so you could lose all your money potentially
In order to lend on a P2P site safely, check that the site you use is regulated by the Financial Conduct Authority (FCA) in the UK. P2P sites in the UK act as a marketplace allowing you to compare different peer's loan rates.
The biggest peer-to-peer lending sites in the UK are Zopa, RateSetter and Funding Circle, but there are lots of smaller ones too.
However, due to the way they lend to their members you need to be prepared to put away your money for a long time.
What's more, the peer-to-peer lending sites need to make money, so they can operate, so each also charges a fee.
If you're looking to save money then p2p lending may well be a sensible option, but there's a few things you need to be aware of.
Firstly, how long are you prepared to have your money locked away for? Peer-to-peer lending only really works if you're happy to have your cash unavailable for one, three or five years.
If you're looking for instant access then an instant-access savings account, some Individual Savings Accounts (ISAs), or even some current accounts may be a better option. While some peer-to-peer sites will let you take out money quickly you will lose a lot of interest.
Although the big peer-to-peer sites are now regulated by the Financial Conduct Authority (FCA) and have a separate emergency fund they use for covering bad debts and shortfalls in repayments, your money is not guaranteed.
If one of the sites were inundated with bad debts and its provision scheme couldn't cover you, then you could lose cash.
For this reason, the FCA has introduced new restrictions (see below) to try to protect consumers.
If you are looking to borrow money, you should carefully read the debt repayment rules depending on what site you're on, and what lender you borrow from.
It may be that a bank overdraft or personal loan would be more suitable for you. You can read our guide on Personal Loans here.
In order to protect consumers, the FCA has placed a limit on investments in P2P agreements for retail customers new to the sector of 10 per cent of investable assets. This is designed to ensure that they do not over-expose themselves to risk.
In addition, new rules introduced last year tightened up the rules around risk management and advertised rates, require investors understand the risks involved when investing, and strengthen rules on winding down if P2P platforms go bust. Even with these new rules, P2P investing remains a much higher risk option than a savings account and should not be regarded as a comparable product. Read more about social lending and P2P platforms: https://www.uswitch.com/investments/social-lending-with-zopa/