For 10 years, peer-to-peer lenders have helped savers find better rates and grow their cash. But how does it work? This is how to compare the different lenders out there

Are you fed up with measly cash ISA rates? Well, you could try switching or you could look for higher returns with a peer-to-peer lender.

Peer-to-peer lenders are online platforms connecting borrowers with lenders (that’s you). In return for lending some of your savings for five years, you can expect a rate of 5% or more. Popular peer-to-peer lenders include Zopa, Funding Circle and RateSetter.

But before you throw all your savings at a peer-to-peer lender, make sure you’ve chosen the right one for you. We asked a spokeswoman from consumer watchdog Which? to explain more:

1. Understand the risks

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Whats the chances something could go wrong?

Investors are directly connected to someone who wants a loan. So the biggest risk is that a borrower will fail to repay. Borrowers are credit checked. But, generally speaking, the higher the potential returns, the higher the risk they might not repay.

2. Check fees

Check out the fees before lending

With most sites you pay an annual fee, either as a percentage of your total investment or the amount of interest earned. You’ll also be charged if you want to get your money out.

3. Remember tax

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Unlike an ISA, you need to pay tax on your interest

Peer-to-peer lenders don’t deduct tax from the interest you earn, so you’ll need to declare this in a self-assessment tax return. Good sites should send annual statements to help with this.

In future, you may be able to invest in peer-to-peer lenders through an ISA. But this is unlikely to happen until late 2015 at the earliest.

4. Choose an established lender

Think Gringotts keep your money safe

Peer-to-peer lenders aren’t covered by the Financial Services Compensation Scheme (FSCS). This means you could struggle to get your money back if a site goes bust – and a couple of smaller sites have gone under in the past few years.

5. Vet the site

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Read the small print

Check that any site you use is a member of the Peer-to-Peer Finance Association – an industry body that requires members to follow certain rules. There are currently eight members, including RateSetter, Zopa, Funding Circle, Lending Works, LendInvest and Landbay.

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