Peer-to-peer lending offers a way for savers to lend directly to borrowers, cutting out the need for banks and building societies — and their charges. Because of this, savers can achieve higher returns than they might from a standard savings account, while borrowers can benefit from lower loan rates. So how does each side work?

Peer-to-peer lending websites work by enabling savers to lend directly to borrowers. By cutting out the middle man (ie, the bank or building society) in this way, the idea is that borrowers benefit from lower loan rates than theyd get from a traditional loan provider, while savers get better returns than they would on a standard savings account.

The growing number of peer-to-peer lending websites has presented more choice of who you can lend to. Traditionally it was just to individuals looking for a personal loan, but now you can choose to lend to small and medium-sized businesses or even property investors. Read more about exactly where your money goes with Laura Howards article .

With most peer-to-peer lending sites, you dont lend your money to just one borrower, though. Instead your cash is split among lots of different ones which helps to reduce the level of risk involved; if one borrower cant meet their loan repayments, it will only have a fraction of the impact.

How peer-to-peer lending works for savers

If you have savings you are prepared to lend, the first thing to think about is how long you want to tie up your money for. Peer-to-peer sites allow you to lend money for as little as a month and as long as five years.

You dont need a large lump sum to invest usually just 10 is enough to start you off. But you can lend much more than this if you want to, as there isnt usually a maximum limit.

There will be fees for lending through peer-to-peer websites its how they make their money and these are usually calculated as a percentage of the interest you earn. However, these fees (as well as estimated defaults) tend to already be incorporated in the advertised rates. In other words, the rate you see as a saver, is the rate you get (though bear in mind it may be variable).

How much interest will you earn?

The amount of interest you earn on your cash will depend on how much you invest, over what timeframe, and the sorts of people or businesses you are lending to.

As a general rule, the longer you are prepared to lend your money for, the higher your potential returns will be, but you must be certain you can afford to tie up your cash for a that period of time.

However, if you do need to get your money out before the terms ends, most sites enable you to sell on your contract to other lenders, so long as they are available to take on your lending under the same terms.

What are the risks involved?

Since April 2014, peer-to-peer lending has been regulated by the Financial Conduct Authority (FCA) which has given savers a greater degree of protection.

For example, youll now be given a more detailed explanation of how the process works as and made aware of all the risks involved. Peer-to-peer lenders must now also have a capital buffer of at least 20,000 in case they run into financial difficulties. And from April 2017, this amount will increase to 50,000 or even more depending on the total amount lent out.

As an investor, you can also turn to the Financial Ombudsman Service if you are not happy with the way a peer-to-peer lender has handled any complaint you have put to it.

However and this is crucial despite being FCA-regulated, peer-to-peer lending is still not covered by the Financial Services Compensation Scheme (FSCS) which protects the first 85,000 of your cash (per banking institution) should it go bust.

Most peer-to-peer lenders have their own protection schemes in place often called provision funds which will cover the lenders losses in the event that it fails. Make sure you find out exactly how you would be compensated in the event this happens.

You will need to be 18 years old to invest with peer-to-peer.

Borrowing via peer-to-peer lenders

Because they need to be seen to protect their investors, peer-to-peer lenders often turn down the majority of loan applicants. So this means will need a really excellent credit history to be accepted for a loan.

If you have CCJs (County Court Judgements) against you then, or you have been turned down by a mainstream loan provider, its very unlikely you will be accepted. You will also need to be at least 21 years old.

If you are shown the green light, you can usually borrow between 1,000 and 25,000, although the amount will vary depending on which website you go to. You can choose how long you want to repay your loan, with terms typically ranging from six months up to five years.

Borrowers can complete their applications for a loan online, and will usually find out within 24 hours whether someone is prepared to lend, and at what rate.