Why I Save With Peer To Peer Lending
For shorter term savings that produce passive income very little beats peer to peer lending at the moment. Thanks to a fragile economy and pitiful bank rates peer to peer lending can be one of the best places to build your emergency savings fund and allocate cash reserves.
Thanks to the Government (and it’s not often I get to say that these days) from last year you’re able to save into peer to peer lending, and other crowdfunding platforms, as part of your ISA limits. This means tax free interest for life – yes please! That’s nearly £20,000 we can tuck away in the tax year.
Peer to Peer investments are not without risks and generally aren’t suitable for tucking away money you could need tomorrow – but most platforms have 1 year investment term options and most platforms allow you to withdraw money with a week to a month’s notice and you’ll only lose your interest. This makes them a great place to put a portion of your emergency funds, or just somewhere to put money you don’t want tied up in the stock market for 5+ years.
Peer to peer lending works like this
Rather than someone borrowing from a bank they can borrow from you – through a third party platform.
This allows you to get a good return on your investment and the middle men (the peer to peer lending platform) gets a lot of capital to work with and makes a nice profit by charging higher interest rates to borrowers.
The peer to peer lending platform manages everything for you – including the vetting of loan applicants and collecting money.
Typically your money will be pooled with others and split across a wide variety of loans so that your individual risk is limited. So even £100 might be lent out to 20 different people wanting a loan. Each individual debtor will have a different interest rate based on their own situation and deemed levels of risk.
What are the Risks of Peer To Peer Lending?
The key risks for peer to peer lending are not numerous but I will go through each of the major risks individually so you can better understand whether peer to peer lending is right for you.
The Default Rate
The default rate is the percentage of loans that fail to be repaid. Peer to Peer lending platforms work out the default rate in advance based on statistical data. The risk here is that the default rates on loans (the number of people not paying) increase dramatically – meaning you can’t receive your capital back as fewer people are repaying. However, this is exceedingly unlikely as even at the peak of the financial crisis default rates barely increased on loans. In addition the larger platforms (Ratesetter and Zopa) have large contingency funds that are specifically designed to cover any losses from bad debts – these contingency funds are created from a percentage of all loans to date and the funds continue to grow.
No FCA Compensation
The financial conduct authority’s compensation scheme protects £85,000 of your money with any major financial institution should they run into difficulties – mainly banks. Peer to peer lending doesn’t have this same protection. Whilst it is unlikely that any of the well-established platforms would run into financial turmoil without repaying their debts (given the large safety funds held) it is a risk compared to not putting the money into a bank account…..with all the interest you could not be getting there!
Interest Rates Rising Elsewhere
If interest rates did rise again and banks and other investment vehicles started offering higher rates of returns peer to peer lending might suffer. One of the major attractions of P2P lending at the moment is that the interest rates are significantly higher than savings accounts and other investment vehicles. If interest rates rise, and banks start wanting our money again, P2P firms will have to increase the rates they offer to lenders – this in turn means they have to increase the rates they charge consumers – which may put financial strain on the companies as they will be less competitive in the marketplace. I personally think that this is unlikely – but it is worth considering.
The Big Platforms
Ratesetter
Ratesetter currently has the highest rate of interest but only thanks to their introductory free £100 offer. This offer applies to when you hold £1000 on their markets for a period of 1 year. And combined with their 3-4% return on investment this makes your interest a staggering 13-14% on £1000.
I have been using this platform for over 3 years and have had absolutely no problems at all. I have quick access money set across their rolling market (which pays a monthly interest rate on a rolling basis) and one year lending. They also offer a five year account which pays the highest rate of interest available but requires you to lock your money away.
I personally use this account as predominantly easy access for my emergency fund.
You can grab the £100 bonus using my referral link if you want – Click here.
Zopa
Zopa currently has the highest interest rates available for short and long term loans paying just over 4%. The downside here is of course there’s no stunning introductory offer.
Zopa offers two accounts – the core range which only lends to borrowers with credit rating scores of A*, A, B & C with rates from 3.4%-5% and the Zopa Plus which lends to borrowers with credit rating scores of A*, A, B, C, D & E (only 20% of your loaned money goes to D&E loans to better spread the risk.
Zopa’s refer a friend scheme offers you £50 (*me too) if you invest £2000 for a year. Which puts a year interest rate to 7.5% for a year – pretty dam hard to beat.
Peer To Peer Lending ISA’s
Since the reforms of 2016 we already don’t have to pay taxes on the first £1000 of interest we receive so for most savers we won’t have to pay any tax. However, this could change in the future so an ISA wrapper can’t come soon enough. You will be able to put your full personal allowance into an ISA wrapper – though personally I will be splitting mine between stocks and shares and P2P ISA’s.
Other P2P Lending Considerations
As with all investments and savings we work through on this site I don’t recommend putting all of your investments into one vehicle as this increases your risk. Even if the returns are the highest not having diversity in your investments is a huge source of risk to your financial future.
Other Types of Crowd Investing
P2P investments actually cover a wide range of topics including business investing and property investing – plus some strange left field investments like pawn brokering for fine art. We’ll look at property and business P2P investments separately as they are more complex and have different risk profiles.
Let me know your thoughts on peer to peer lending in the comments below!