What is peer-to-peer (P2P) lending?
With interest rates on savings accounts and cash Isas struggling to beat inflation, many savers are thinking about putting their money into riskier investments that offer a better rate of return.
Peer-to-peer lending is similar to saving with a bank, but pays much higher rates of interest. But unlike a traditional savings account, you can lose money.
Peer-to-peer lending sites match up savers, who are willing to lend, with borrowers - either individuals or small businesses.
By cutting out the middleman and not having the overheads of traditional banks, peer-to-peer sites can often offer you more favourable rates, whether you're a lender or a borrower who has struggled to get a personal loan elsewhere.
You invest through a website, but lenders work in different ways. Some allow you to choose who to lend to, while others spread your investment out on your behalf.
Borrowers are credit-checked by a credit reference agency, and also have to pass a peer-to-peer site's own credit-worthiness tests in order to qualify for a loan. Some lenders allow you to choose the credit-worthiness of a borrower - choosing a riskier person often results in higher rates.
The sites also take care of collecting money from borrowers.
Peer-to-peer (P2P) lending sites rated
- Read our review of Funding Circle
- Read our review of Ratesetter
- Read our review of Wellesley & Co.
- Read our review of Zopa
Peer-to-peer (P2P) lending: the risks
By being connected directly to someone who wants to borrow, the most immediate risk to your money is if a borrower fails to repay what you've lent them (known as 'defaulting').
Sites manage this risk in different ways. Zopa, for example, splits your investment into £10 chunks, to be spread out across multiple loans. This helps spread risk, and means that if one borrower fails to repay, your whole investment doesn't take a hit.
Zopa and RateSetter offer compensation funds which should automatically cover you if a borrower defaults.
However, these compensation funds are not infinite. It's possible that in a crash where lots of borrowers default at the same time, they could run out of money, although it hasn't happened so far.
Funding Circle takes a different approach: there's no compensation fund, but there are higher returns on offer.
Most importantly, peer-to-peer sites aren't covered by the Financial Services Compensation Scheme (FSCS) which guarantees your savings with banks and building societies up to the value of £85,000.
Peer-to-peer sites – what to watch out for
If you're a lender, there are a few things you need to watch out for when using peer-to-peer lending sites:
- RateSetter and Zopa show the rates of return you can expect after they've deducted their fee. On Funding Circle, the rates you see usually don't include their 1% annual fee.
- You'll need to weigh up the risk of losing some or all of your money. The risk is likely to be lower if there's a compensation fund.
- Some peer-to-peer lending sites will allow you to withdraw funds early if you wish to, although there will be a fee.
Will I pay tax on peer-to-peer lending profits?
Returns on peer-to-peer lending are currently taxable as income. You'll need to tell HMRC how much interest you earn at the end of the tax year.
However, interest earned on peer-to-peer lending falls under the Personal Savings Allowance. That means basic-rate (20%) taxpayers can earn £1,000 a year in interest tax-free, while higher-rate taxpayers can earn £500 a year without paying any tax.
A new type of Isa called the 'Innovative Finance Isa' was introduced on 6 April 2016 for peer-to-peer lending. You are able to set up your Isa with an individual platform so that any interest paid by borrowers is tax-free.
The government is also consulting on whether to extend this to equity and debt crowdfunding.
Other peer-to-peer lending sites
Funding Circle, RateSetter and Zopa are the three biggest peer-to-peer lending sites in the UK, and founding members of the Peer-to-Peer Finance Association - a trade body which has set out operating standards that formed the basis of the move towards formal regulation by the Financial Conduct Authority in April 2014.
However, many other peer-to-peer lending sites have emerged. These include:
- Lending Works
- Madiston LendLoanInvest
- Wellesley & Co