I’d like to introduce you to Peer to Peer lending (P2P), an alternative investment asset class to the traditional equities, bonds, funds or cash.
You might have seen names such as RateSetter, Funding Circle, Zopa etc advertised in London underground or perhaps more generally.
P2P lending is a £2.2billion market in the UK and has had extraordinary growth since it began in 2005, with the biggest driver being the returns on offer.
This growth is also being seen globally in such places as the US (e.g. Lending Club), EU, India, China; reinforcing the trend in the use of technology to cut out the middleman.
On 6 April 2016, HMRC stated its guidance to people investing in peer to peer loans:
“The advantage of peer to peer loans for lenders is that they can generate higher interest rates that exceed the interest that could be earned from banks and other financial institutions.”
What is Peer to Peer (P2P) lending?
P2P lending is the matchmaking of people who want to borrow money and people who want to lend money as investors (e.g. you).
This matchmaking happens through platforms facilitated by the internet.
What's really interesting is that P2P lending completely cuts out banks from the equation.
Those savings (e.g. the bank fee, cost of branches etc) of not having a traditional middleman to pay are then passed onto you.
P2P has had rapid growth since 2008 partly driven by the need to fill the funding gap and provide an alternative to bank loans.
The money you invest via P2P lending plays an important role in the economy. It's typically lent to highly creditworthy individuals, businesses or property developers.
What is Peer to Peer lending not?
P2P lending is not crowdfunding. Both involve raising money online from various investors, however, crowdfunding platforms issue equity (i.e. small ownership in a company) rather than debt (i.e. a loan).
P2P is explicitly not an alternative to a normal savings account. As an investor, you're exposed to abit more risk, primarily because you don't have the liquidity (easy access to cash) that comes with savings.
However, for the risk (which is way below the risk of investing in shares), you get access to much better returns than a mere savings account.
What is the attraction and Why invest?
This new way of investing gives you and me access to invest in an asset class that was previously only reserved for banks and institutions!
- Good returns – As stated by HMRC above, you will earn better returns (interest income) than through regular savings. Returns vary as covered below.
- Lower costs – P2P platforms save over 2% in operating costs compared to a bank according to Deloitte. Such savings are shared between you and the platform.
- Fight inflation – Typical rates of return offered far outstrip the rate of inflation, making your money work harder for you.
- Lower risk – Only highly creditworthy borrowers are lent money by P2P platforms, with an average rejection rate for borrowers across platforms of almost 80%.
- Flexibility – You have the ability to choose the level of risk you want exposure to and also the return received.
- Diversification – Your money is lent to various sectors (consumers, businesses, and property lending). Within these sectors are sub-sectors (e.g. hotels, leisure, child-care and health facilities etc).
- Low correlation with stocks & shares – This means that with P2P in your portfolio, any rise or fall in the value of your shares will not affect your p2P holding.
- Invest through ISA & SIPP – From 6 April 2016, you can now invest in P2P via the Innovative Finance ISA. RateSetter also gives you the opportunity to invest through your SIPP. These make your gains tax free!
- Liquidity – You can have access to your money depending on the type and term of the loan.
- Transparency & Authenticity – P2P has a feel-good factor to investors due to its ethical standards and democratisation of finance. Data on rates are published on platform websites.
What kind of returns can you expect?
Returns from P2P vary widely and have everything to do with the level of risk you want to take.
If your money is invested in loans to individuals with good credit histories, you might yield 4% or 5% per year.
Loans to property developers might yield 6% to 9%-plus, whilst loans to small businesses might yield 9% to 15%-plus.
It is safe to assume that is a P2P loan carries a high-interest rate of return, then it is likely to involve a higher level of risk.
Below is an example of how P2P returns typically compare to returns from savings accounts:
Who can invest in peer to peer lending?
Anyone can invest with a minimum of £10 and no maximum limit.
This used to be the domain of the institutions but is now available to retail investors.
P2P is FCA regulated and platforms such as RateSetter, Funding Circle, and Zopa, for example, have full FCA authorisation.
What are the key risks?
- No FSCS – The Financial Services Compensation Scheme (FSCS) covers you for up to £85,000 for deposits in a UK bank account.
- However, P2P is an investment (not a bank deposit) as is your investment in shares (which has no protection at all).
- P2P platforms do however have built-in protections (see below). Other protections include a first and second charge on properties or the requirement of personal guarantors on loans.
- Risk of default – Although the risk of a borrower not paying back is low, they still exist. Defaults rates range from 0.1% to 3%, with the industry average at around 2%. See below for how the top platforms protect you as an investor against the risk of default they face from borrowers.
- The platform goes bust – Strictly speaking, your loans are between you and the borrower. So if the platform goes bust, you're still owed.
How can you invest?
Although this market is growing fast, the three below give the best returns and make up most of the UK market:
Pretty similar to investing in a savings account. It is customisable. E.g. Say you get offered 5.1% return – if you want your money invested quicker, you go for a 4.9%, or wait to see if it can be matched at 5.4%.
It also allows you to instantly reinvest the interest you earn and benefit from compounding.
- Current rates: Earn from 3.1% (easy access), 4% (1 year), 5.7% (5 years)
- Fees you pay: £0 – No initial fees or annual management fees!
- Protection: They have a large Provision Fund (with 100% track record). It provides a buffer against poorly performing loans. It reimburses you if a borrower misses a payment. If a borrower defaults, the Provision Fund would take over the loan, repaying any outstanding capital to RateSetter investors.
- Amount lent so far: £2.2billion
- Number of active investors: 59,204
- Minimum/Maximum investment: £10/No Limit
Offers the purest Peer to Peer system and lends primarily to businesses.
- Current rates: Projected return of 4.8% (conservative) or 7.2% (balanced)
- Fees you pay: 1% annual fee
- Protection: Its new Autobid system spreads your money over a wide range of borrowers. So if one fails to repay, it won't hit you too badly.
- Amount lent so far: £3.1billion
- Number of active investors: 76,867
- Minimum/Maximum investment: £1,000/No Limit
Zopa is the longest running of all the P2P platforms and operates similar to putting money in a fixed savings account.
It's currently not accepting new investors due to high demand from existing investors. Feel free to join the waiting list.
- Current rates: Projected return of 3.7% (Zopa Core) or 4.5% (Zopa Plus)
- Fees you pay: 1% annual fee
- Protection: Zopa used to have a Safeguard Fund up until June 2017, but this has now been withdrawn for new investors. Investments are well diversified.
- Amount lent so far: £2.96billion
- Number of active investors: 76,000
- Minimum/Maximum investment: £1,000/No Limit
In summary, Peer to Peer Lending is an asset class that is here to stay. The sector is regulated and your investments can now be held in a tax-free ISA. Returns remain very attractive, more people are investing and awareness is growing fast!
Hopefully, this guide serves to educate more people about the opportunities Peer to Peer lending presents.
Is Peer to Peer Lending something you have previously considered? What are your key concerns?
Do please share this post if you found it useful, and remember, in all things be thankful and Seek Joy.