What is peer-to-peer lending?

Peer-to-peer (P2P) is a way of lending and borrowing that is fast becoming an important source of alternative finance.

In the last few years, a raft of P2P platforms have launched that match investors (lenders) with money to lend (sometimes as little as £10) to individuals or companies that need to borrow. Two of the biggest are Zopa and Funding Circle.

Peer-to-peer lending and can offer rates for both parties that are better than those offered by the high street banks (as they have lower costs).

Peer-to-peer lending platforms effectively act as a matchmaker, and make their money from the spread between what a lender gets paid, and what a borrower pays to lend the money.

The P2P lending industry has accounted for over £4.5bn in loans in the past 10 years, with more than £2bn of that total being loaned in the first 10 months of 2015 alone.

What’s in it for me?

Potentially, quite a lot. It’s no secret that savers have seen the interest rates they can get from their money plummet in recent years. With peer-to-peer lending this group could benefit from interest rates of between 5 - 10%, although this depends on a few factors, including the risk you’re willing to take on your investment. The returns also can be impacted by how long you’re happy to invest your money for – the longer the better.

As a borrower, the interest rate you’re eligible for is dependent on your credit rating. The better your rating, the better rate you should expect as you’re at less risk of becoming a ‘bad loan.’

Starting in April 2016, P2P lending platforms will also be able to offer a new Innovative Finance Isa, allowing consumers to gain a certain amount of interest tax-free (predicted to be roughly £15,000).

What different types of P2P lending are there?

While peer-to-peer lending that matches people like us is the longest running market, there are also several more peer-to-peer lending sites that are a bit more niche.

Peer-to-business lending is one such area. By using these sites you can invest your money into companies rather than individuals.

There are also specific platforms for peer-to-peer landlord investing for people who want to invest their money in property-backed projects. While there are good interest rates available, as with all peer-to-peer lending, there are risks involved.

Some platforms, such as Invest & Fund, allow you to invest in property development projects that you want to back and are vetted by them.

How safe is my money?

Well, peer-to-peer lenders aren’t covered by the Financial Services Compensation Scheme (FSCS), which covers savings up to £85,000 (£75,000 from 1 st January 2016) per person, per institution. What this means for investors using peer-to-peer lenders is that there may not be any compensation if the peer-to-peer lender you’re using fails, although the industry has developed ‘bad debt funds’ to help reassure investors.

Three of the longest-running peer-to-peer companies – Zopa, Funding Circle, and RateSetter have so far not defaulted on any funds lent via their platforms.

What does help mitigate the risk is that your investments can be spread across multiple borrowers rather than just one or two.

The peer-to-peer lending models expect a few borrowers to default on their payments (any can manage these through ‘bad debt funds’) but hope that the majority of borrowers will pay back the money they’ve been lent.

Since April 2014 the FCA (Financial Conduct Authority) has been responsible for regulating the peer-to-peer industry, and many platforms are currently going through the authorisation process.

So, is peer-to-peer lending for me?

Peer-to-peer lenders aren’t banks and don’t offer risk-free savings accounts. There is an element of risk involved with peer-to-peer lending, so weighing-up the pros and cons before you invest is important. Lastly, it’s worth remembering that as the industry is quite new, its robustness hasn’t been tested through a recession yet.

If you’re after a decent interest rate and comfortable with the risks involved, then peer-to-peer lending may be worth exploring as part of your investment portfolio. Before making your mind up, why not take a look at what our Smart Money People have said about the peer-to-peer platforms they’ve borrowed from? And don’t forget to leave a review if you’ve any experiences of your own to share.