Peer to peer lending has been around the UK for fifteen years. It was designed to remove the middleman ‘the bank’. Peer to peer platforms brings lenders (investors) and borrowers together. P2P lending is a direct approach that allows investors to earn high-rate interest while the borrowers pay a low interest rate since the platforms have fewer overheads compared to a bank.
However, peer to peer does not remove the middleman completely. The platform does the heavy lifting like vetting the borrowers, managing transactions and chasing borrowers for repayments and for doing all this, they take a fee. Nonetheless, financially it works out better for both the borrowers and the lenders. But there is high risk for the lenders than they would have with a bank savings account.
How does P2P lending works?
There are a lot of peer-to-peer lenders to choose from in the UK market. As an investor, you will have to register yourself on the platform you prefer and put in the money either through direct transfer or debit card.
You then have to choose the interest rate you want and the term for the loan you are willing to lend for. When the borrower has repaid the loan with interest, you can withdraw the funds, or you can re-invest your returns to grow your money further.
Some platforms allow you to select whom you would lend the money to, but it is more common for platforms to divide your funds between multiple borrowers for risk reduction. There are different investment products offered by the peer to peer lending platforms. Each platform offers different products and interest rates. Before becoming a peer to peer investor, make sure to compare different platforms and their products to choose the one best suitable for your financial needs.
Is P2P lending a safe investment option?
Peer to peer lending is also called ‘investing in loans’. Similar to other types of investments, putting your money in for earning a return is a financial risk. Every peer to peer lending platform in the UK is regulated by the Financial Conduct Authority (FCA). The FCA protects the platforms from malpractice. But it does not protect you from losses.
Unlike banks and building societies, the peer to peer lending platforms is not covered by the Financial Services Compensation Scheme. This means that if the platform goes bust, you can lose all your money. However, most providers have set up a reserve fund to protect investors against suck risks. This way, your money gets repaid to investors even if the borrowers default. But even these funds are not bottomless and can run out in exceptional circumstances. The likelihood of something like this happening is low but not zero.
Do Peer to Peer borrowers’ default often?
Defaulting borrowers is one of the biggest risks of peer to peer investing. But fortunately, most well-known and experienced platforms have an action plan for this. The big P2P market players are more transparent, either by giving each borrower a rating or factoring ‘bad debt’ into your predicted return. You can see their rating or risk category when investing in that platform. This way, you can make an informed decision according to your risk tolerance. Usually, with high-interest rates comes more financial risk.
What are other risks associated with P2P lending?
With peer to peer lending, you make money depending on the interest rate you choose. Usually, the interest rates can vary from 1% to 7% based on the level of risk you willing to take. Interest rates higher than this are also available, but that means a higher risk of losing all your money.
How much should you invest in peer to peer lending?
The good thing about investing in peer to peer lending is that you can start with as little as £10, with no maximum limit. However, the FCA has imposed a limit on how much the first-time peer to peer lenders can invest, protecting them against default. Under this rule, new lenders cant put more than 10% of their investable assets into peer to peer lending unless they get independent financial advice. Each peer to peer lending platform in the UK is regulated by FCA, so they must comply.
If you are keen on investing in peer to peer lending, then it is worth taking this venture to maintain a balanced investment portfolio to manage the risk better. You need to work with your Independent Financial Advisor to choose the most suitable peer to peer platform for your financial goals and risk tolerance. However, remember not to invest more than you can afford to lose. The most common mistake that people make while investing in peer to peer lending is treating it as a savings scheme rather than a medium to high-risk investment.
Are there any alternatives to P2P lending?
One alternative to peer to peer lending is Innovative Finance ISA. It is a type of peer to peer lending. However, your loans are held in an ISA tax wrapper. This way, you don’t have to pay tax on the interest you earn.