Peer-to-peer (p2p) lending is a way of investing and borrowing money with a more cost-effective middle man than a bank. P2P involves you lending to or borrowing your money from an individual who may not be able to gain financing through the traditional route of a bank loan. There's also a bigger community element in that you often can find out some stats of who you're lending money to. As an example, when you lend money through Zopa (more on this platform below), you can see where the borrower is from, their age, how much they're borrowing and what they're borrowing the money for.
Unlike saving your money in a traditional bank account where your money is pooled with others' and lent out to individuals for a much higher interest rate with the bank taking the majority of the earnings, you take most of the earnings from putting your savings in p2p lending. The p2p lending platform takes a small percentage (much smaller than what banks take) of the interest you earn on your money which covers admin costs and a small amount to help grow the platform.
History and growth
Having been around for less than 20 years, with many smaller less well-known platforms less than 10 years old, p2p lending is still a very young investment platform. Its strength and growth as a viable way to achieve above average returns on your investment indicates that it will soon be as common as having an ISA. In fact, demand for the platform has helped the industry become regulated by the Financial Conduct Authority (FCA) and talks of introducing an ISA for p2p lending is gathering momentum with potential availability in the next decade.
Returns - the good, the bad and the ugly
In the UK, inflation is low at 1%. Despite this, the average easy-access savings account with a bank is offering just 1.4%. For money that you lock away for a fixed term of 1 - 7 years, you can get a better return of between 1.75 and 3.11%. It's hard to dismiss these fixed-term rates but given the added restrictions on withdrawing the money (many don't allow this during the term) or facing a penalty for doing so make these savings accounts less attractive. Fixed-term accounts also often require a minimum investment of £500 - £5000. Regular savers offered by bank accounts often boast the best interest rates but you're restricted in other ways: you must pay in a certain amount every month. If you invest any more than the amount stipulated, you will either be forbidden to do so or gain no additional interest on the surplus making it pointless to save more than the limit.
Save and invest your money in a p2p lending platform and you can earn between 3.2 and 12%. Why does the interest rate vary so much? The rate you get depends on which platform you use, how long you choose to invest and your risk tolerance.
Here are a few examples from the most established p2p lending platforms available in the UK:
1) Zopa: investors can lock their money up for 3 years and earn 4% or for 5 years to earn 5.1%. This doesn't mean you can't access your money at all during that time. Using their 'rapid return' functionality, you can 'sell' your loan part (your money is loaned out in multiples of £10) to another investor. You're charged a small fee in exchange. Not the most liquid investment but a helpful option if you need the money. Read more on investing in Zopa.
2) Funding Circle: investors spread their money in multiples of £20 and lend their money out for a different amount of time depending on the loan conditions but the average return is 7% per annum. If you need your money earlier than the length of the term then you can 'sell' your loan part to another investor for a small fee. Funding Circle's not as transparent about the liquidity of your money unlike Zopa's clear 3- or 5- year option. This makes it more difficult to understand just how easy it will be to get your money back quickly if you need it. Read more on investing in Funding Circle.
3) LendInvest: as LendInvest is a p2p marketplace for real estate mortgages this platform works differently. Average returns are 6.65% and your money is secured against the property. This doesn't mean your capital is not at any risk but at least you have it secured against another asset if the borrower does default. You have to invest a minimum of £1000 per loan which makes this one tricker to invest in for those just starting out. Read more on investing in LendInvest.
Other benefits of p2p lending
There's a whole host of other reasons why this is a suitable way of investing for many:
- Quick set-up and easy management. All platforms provide instant online access and signing up takes less than 10 minutes. You may need to wait a short while before you can transfer money in but this should take no longer than a couple of working days. You can easily change how you invest by setting up a direct debit to save regularly or just transfer a lump sum.
- No credit checks. Unlike current or checking accounts that have high interest rates, you don't have your credit rating checked before you invest.
- Easy to track. The dashboard is often set up in such a way that you can see easily how much you've lent out, what you've earned, what you've lost in earnings (due to defaults) and what the total value of your investment is. This changes daily as your interest payments come in more regularly than once a month or once a year (unlike most bank accounts).
- Easy to declare earnings for tax purposes. Just before the end of the financial year in April, you'll be able to download your statement and template letter to send to HMRC so that can (and you must) declare your earnings.
It's hard to argue with the superior returns. On the returns alone p2p lending platforms pretty much outperform any savings account with a traditional bank. They can sometimes achieve returns like those you'd see from holding an index fund. That said, you should expect some loss of your earnings due to defaults. This is especially true of Funding Circle but overall my earnings and losses combined still mean that my investment comes out as the top earner of my portfolio (excluding my pension).