Savers and borrowers should consider the pros and cons of peer-to-peer lending, while peer-to-peer Nisas are set to become an option.

Key P2P points

• Potential of attractive rates for both savers and borrowers as the ‘middle man’ is removed
• Less protection than with more traditional savings and loans options
• For savers, the higher the risk, the better the likely rate of return
• For borrowers, the riskier their venture, the more they will have to pay for their loan
• Gocompare.com helps you see P2P options against traditional savings and loans choices

What is peer-to-peer lending?

Peer-to-peer lending — also known as peer-to-peer saving, crowdlending or P2P — allows individuals to loan money directly to borrowers, facilitated by P2P sites such as Zopa, Funding Circle and RateSetter.

Because banks and building societies — the ‘middle men’ — are taken out of the equation, borrowers may get lower rates while savers could get better interest rates than those available with regular savings accounts.

However, the potential for better returns must be balanced against the potential risk — returns are not guaranteed, and the capital itself is potentially at risk.

If you enter Gocompare.com’s savings and/or loans comparison service, you’ll see peer-to-peer options listed clearly alongside more traditional options.

You’ll have the chance to limit your search results to just peer-to-peer choices — or to take such P2P options out of the results you see.

How does P2P work?

Peer-to-peer sites allow you to lend (‘invest’) money, perhaps for as little as one month or as long as five years.

Did you know.

• Plans for peer-to-peer Nisas are under consultation, but the product may not become a reality for some time

You don’t need a large lump sum to invest — some sites accept deposits of just £10 a month.

Those in receipt of the money — individuals and businesses — are likely to have to undergo stringent checks before being accepted for a loan.

Crowdlending companies need to protect their investors in order to build trust and confidence in their service, so unless applicants for loans are thought to have a good credit rating they may well be turned down.

There are fees involved in lending through P2P websites — it’s how they make their money, after all — but they’re usually calculated as a percentage of the interest savers earn and borrowers pay.

These fees are usually incorporated into the advertised rate, so the rate you see should be the rate you receive.

• Appendix. Peer-to-peer lending case studies

How much control do I have?

P2P sites generally allow you to choose what type of borrower you lend to.

This will be based on the borrower’s perceived risk and, in some cases, on what they need the money for.

The higher the risk of the borrower, the higher the interest rate you can charge — and the higher the risk associated with your investment.

Much like a savings account that offers monthly interest payments, P2P lenders receive monthly repayments on the sum they’ve invested.

However, withdrawing money or accessing your full investment can be complicated.

Did you know.

• The P2P industry is regulated by the Financial Conduct Authority
• Savers’ money does not qualify for protection under the Financial Services Compensation Scheme
• P2P companies should have their own protection schemes in place

Some P2P companies will allow you to exit your arrangement if they’re able to sell your contract to another investor, while others will charge a fee for access to your capital before the term ends.

For this reason you should think about being prepared to tie up your investment for the long-term.

What are the risks of P2P?

Since April 2014 the peer-to-peer industry has been regulated by the Financial Conduct Authority (FCA), which gives savers an element of protection.

But money invested in P2P services is not covered by the Financial Services Compensation Scheme (FSCS), which protects the first £85,000 of your savings in the event of an authorised firm becoming insolvent or ceasing trading.

Reputable peer-to-peer companies do have their own protection schemes in place, though.

While they take extensive measures to vet clients it’s always possible a borrower may default on their loan to you, so P2P companies usually have financial buffers to absorb these losses.

By April 2017 they will be required to have at least £50,000 of capital in reserve for such an eventuality.

Peer-to-peer operators are also required to have insurance to pay for a third-party collection agency.

This means that, in the event of the P2P company itself going bust, you’ll still be able to recoup your money from your borrower.

You should bear in mind that this could prove to be a lengthy and convoluted process, though.

To help mitigate risk, investors are usually encouraged to invest smaller amounts in many borrowers, rather than putting all their money in one place.

Did you know.

• No interest is paid while you’re waiting for your funds to be lent out

This also helps absorb the negative effects of bad debt.

It’s worth noting that no interest is paid on your cash while it’s waiting to be lent out.

A modest sum (perhaps around £1,000) is likely to be lent swiftly, but it can take some weeks to find a borrower for larger amounts.

Drip-feeding in your investment across many borrowers could help to ensure that your money is working hard soon after it leaves your pocket.

The interest you earn from P2P savings is subject to income tax in the same way as normal savings, and you’re not currently able to reduce your tax bill by subtracting the losses of bad debt.

There’s an increased risk, not covered by FCA, but RateSetter’s provision fund mitigates much of this risk and tips the balance of reward versus risk

Joe Levey, P2P lender

For example, if you lend (invest) at a rate of 8% but — because of bad debts from a borrower — you only receive 5%, you’ll still be taxed at 8% on the interest you do receive.

This can substantially affect returns, but spreading your cash amongst multiple borrowers could help to counteract this risk.

In December 2014 the government announced that it planned to change rules on P2P lending by allowing those lending money through P2P platforms to offset any losses they make on bad loans against any gains they make on other loans.

This will be effective from December 2016, and through self assessment will allow individuals to make a claim for relief on losses from April 2015.

Peer-to-peer Nisas

New Individual Savings Accounts (Nisas) can be explained as tax-free ‘wrappers’ that are placed around your savings or investments.

This means that you don’t have to pay any tax on the interest that you earn — read more in our beginners’ guide to Nisas .

In the March 2014 Budget, plans were announced to allow peer-to-peer savings options to have such a tax-free wrapper around them for the first time.

However, planning is needed before this plan can be implemented. In October-November 2014, the government conducted a month-long consultation with the industry to work out the best way forward.

This prompted some experts to predict that peer-to-peer Nisa options would be available in 2015

One of the major decisions would seem to be whether to include peer-to-peer under existing stocks and shares Nisas or to introduce a new, third type of Nisa alongside the stocks and shares and cash Nisa options.

Increasing competition

The government has made it clear that they see P2P lending as one of the solutions to the lack of competition in the banking industry.

In the 2014 Autumn Statement, the government announced that it was planning to review the financial regulation which currently stands in the way of institutional lending through P2P platforms.

I took a small, short-term loan from Zopa to pay off a credit card bill as I was able to get a much lower interest rate

Simon Coopey, P2P borrower

It also plans to consult on the introduction of a ‘withholding regime for income tax to apply across all P2P lending platforms from April 2017’ which would allow ‘many individuals to resolve their tax liability without them having to file for self-assessment’.

The official documentation read: [The 2014] Autumn Statement announces support for P2P and crowdfunding platforms through a package of measures to remove barriers to their growth from regulation and tax rules.

These include a new bad debt relief for lending through P2P platforms; a consultation on whether to extend Isa eligibility to lenders using crowdfunded, debt-based securities and an intention to review financial regulation which currently stands in the way of institutional lending through P2P platforms.

By Rachel England

Appendix: Peer-to-peer lending case studies

Simon Coopey, a 33-year-old sales co-ordinator from Newport, borrowed money from Zopa before becoming a lender (interviewed in November 2014)

I took a small, short-term loan from Zopa to pay off a credit card bill as I was able to get a much lower interest rate. A few months after borrowing, I decided to be a lender too.

Having been a borrower it felt like ‘the community’ had helped me out, so it seemed right to return the favour and help the community out in return.

The experience I had as a lender was really good — you can use the service as you would a savings account, transferring in money each month or as one big lump sum.

The control panel offered a choice between types of lenders — those with higher credit ratings which were lower risk, and those which were considered slightly more risky to lend to but who would be charged a higher rate of interest, potentially earning you more money.

As peer-to-peer lending comes of age, I would wholeheartedly recommend people look into it. From a social aspect, it feels good to bypass the large banks and lend to actual people.

Your investment gets split into smaller chunks, so if you saved £200 Zopa might lend £10 to 20 different borrowers to spread the risk — and you get to see the reasons people want to borrow.

Among the boring ‘home improvements’ and ‘debt consolidation’ descriptions I had a gentleman who had found ‘the perfect car for [his] wife — VW Beetle in yellow’, and a lady who was using her loan to start a small home business selling jams and chutneys.

Joe Levey is a former teacher and retired sales director from Sheffield. He loaned money through RateSetter (interviewed in November 2014)

Aged 65 and retired, I was looking for rate of return on savings offered by banks and building societies that was above derisory and below inflation rates.

I looked into peer-to-peer lending 18 months ago after seeing press and internet coverage. RateSetter was my initial choice more by luck than judgement — I have also invested with Zopa.

For a pensioner the adage ‘return of capital, not return on capital’ is paramount, since insufficient investment time remains to repair mistakes.

My experience with peer-to-peer and especially RateSetter is that you could possibly triple returns versus traditional lenders.

There’s an increased risk, not covered by FCA, but RateSetter’s provision fund mitigates much of this risk and tips the balance of reward versus risk.

RateSetter is easy to use and provides a secure investment of funds. They give good feedback via email and offer four products on their platform: a monthly and yearly saver, a three-year term product and a five-year term product. Depending on age and ability to accept some risk I would recommend peer-to-peer lending.