Peer to peer lending or P2P is a method through which you can lend funds to businesses or individuals. So, you as a lender will earn interest and get your money back when the borrower repays the loan. However, peer to peer lending can be riskier compared to the traditional savings account.
In this blog, we will cover the following:
- What is P2P lending?
- P2P lending risks
- How to start investing in P2P lending?
- Tax and P2P lending
What is P2P lending?
Peer to peer lending platforms works like marketplaces. It brings together people who want to borrow money and those who want to lend money. The borrowers can be businesses or individuals. It is an easier and quicker way for borrowers to get a loan.
Some peer to peer platforms automatically divides your funds between multiple borrowers, while others give you the option of choosing the borrower you want to lend money to. However, just like other investments, peer to peer comes with its own risks, such as if a borrower defaults on loan, you could lose all your money.
How to start investing in P2P lending?
In order to start investing, you have to follow these three steps:
If you wish to lend funds, you first need to compare all the peer to peer lenders available in the market. Compare the interest rates and terms to select the one that is suitable for you.
- Open an account with a peer to peer lender of your choice and put some money in using your debit card or direct transfer.
- Review the loans available or go for auto-invest to let the platform do the choosing for you. You sit back and relax.
- You can select a loan with different terms, including 3 or 5 years. However, you may have to pay a fee to lend money on some platforms.
Understanding the Risks of Peer to Peer Lending
Peer to peer lending has several risks associated. So, before you decide to invest, you should understand these risks and learn how you can reduce them.
Risk of Default
The business or person you lend your money to may fail in repaying the loan. This is called defaulting. The higher the default rate, the more people will be unable to pay back the loan.
Unlike building society and bank savings, the funds you lend through a peer to peer platform are not protected by the Financial Services Compensation Scheme. But most providers have a provision or contingency fund in place, designed to pay back the money to the lender in case the borrower defaults.
Every platform has its own provision funds, so ensure you know what is covered before you become a lender.
The risk of peer to peer lending platform going bust
In case the P2P platform goes bust, you could lose your money. But if the platform is regulated by the Financial Conduct Authority (FCA), the platform has to keep the money in ring-fenced accounts separate from their own funds.
The risk of late or early repayment
If your loan amount is repaid late or early, you may make less interest than expected. If the loan gets repaid early, you can lend out the money again. But you may not be able to lend money at the same interest rate.
Tax and P2P Lending
Returns that you earn through P2P lending is classed as income, so it is taxable. However, most people don’t pay tax because of their Personal Savings Allowance (PSA). The PSA allows basic-rate taxpayers to make up to £1,000, while the high-rate taxpayers can make up to £500. The interest you earn above your personal allowance is taxable and paid at your highest marginal tax rate.
An Innovative Finance ISA or IFISA lets peer to peer loans be held in Individual Savings Accounts (ISA). This way, you can earn interest by lending into P2P loans tax-free. With an IFISA, you can invest up to a limit of £20,000 per tax year. The £20,000 annual allowance can be shared between different ISA types: cash ISA, stocks & shares ISA, IFISA and Lifetime ISA. The biggest benefit of IFISA is that you don’t have to declare the ISA interest earned, capital gains or income to the HMRC.
* The information on this page is not advice. Always ask financial experts for advice if you aren’t sure about your investment choices.