Peer to Peer lending and investments

The first thing you will notice when you look at a list of peer to peer (P2P) lending or investment accounts is their eye-catching interest rates. 

These rates are usually considerably higher than those offered by most traditional savings accounts, and are sometimes into double digits. 

While these interest rates may be achievable with a peer to peer account, and undoubtedly seem more attractive than a standard savings account, there is a far higher level of risk involved, and more caveats to consider when deciding whether to take the plunge with peer to peer investments or stick to more conventional savings.

What is a peer to peer investment account?

Peer to peer investment or lending, in its purest form, means lending your own money to individuals or businesses you are matched up with that need a loan. 

By cutting out the middleman, borrowers benefit from competitive loan rates, while lenders (investors) earn significantly more interest on their money than they would in a traditional savings account.

How does it work?

You sign up with a peer to peer lending company (such as Zopa, Funding Circle, Ratesetter or Lending Works) which does most of the hard work for you, carrying out credit, identity, and fraud checks against prospective borrowers. 

Potential borrowers declare how much money they wish to borrow, and, if they pass the checks, they’re matched against lenders, such as yourself, who are looking to earn a decent rate of interest on their savings.

Peer to peer lending rates

Currently, you can get interest rates of up to 6.5% with P2P lenders such as Funding Circle, and 2% to 4% with Zopa. 

In comparison, most savings rates are miserably low at the moment and according to Moneyfacts, fell to the lowest levels on record in August 2020.

Some peer to peer lending companies specialise in lending to individuals or businesses in specific areas of industry or business, such as the building industry, the farming industry, the property market, or small businesses. 

Other peer to peer lenders have a wider remit, providing loans to individual borrowers on the open market.

Applying for a peer to peer savings account is quick and easy, and usually carried out online. 

As part of the process, you will need to supply some form of ID, such as a passport, and proof of your current address and any other addresses from the past 3 years, if applicable. 

With most peer to peer lending companies, you can open an account with as little as £10.

How risky is peer to peer lending?

The main risk with peer to peer lending is that your savings are not covered by the FSCS (Financial Services Compensation Scheme). 

This scheme protects up to £85,000 of savings per individual held in authorised financial institutions such as banks and building societies. 

Should an authorised financial firm collapse, any money (up to the limit) you had saved with them would be safe.

However, should your peer to peer lending provider go bust, you have no such protection and could therefore lose your entire savings capital.

In reality, you may not lose everything because some peer to peer lending companies provide some kind of alternative security scheme for your funds. These schemes vary from firm to firm, so be sure to read all of the small print.

In order to ease some of your fears and to provide transparency, some peer to peer lending companies advertise the amount of defaults (i.e. missed payments) versus successful loans. 

Others have a fund of money that can be used to repay any losses you suffer due to defaults.

Despite the high interest rates on offer, it should never be overlooked or forgotten that peer to peer lending is a risky undertaking. 

Given the level of risk, and the lack of any guaranteed security for your capital, it is probably more accurate to call it peer to peer investment rather than saving, and to treat it as such.

FCA rules

The Financial Conduct Authority (FCA) tightened up the rules for peer to peer lenders in 2019. 

New investors who have not sought out financial advice can only invest up to 10% of their investable assets (excluding your main residence).

How does peer to peer lending work?

All peer to peer lending companies work differently, from who they lend to, the way they assess potential borrowers, the method by which they spread investments and the way they repay investors. 

Before choosing a peer to peer firm, make sure you read all of the FAQs and check some external reviews to ensure you fully understand how that company works.

In general terms, there are two ways in which you can manage your peer to peer investments:

You choose the individual loan or loans you wish to invest in, based on information provided online by the peer to peer company. 

This is a comparatively risky endeavour unless you are very experienced in making such decisions, and have the time and the willingness to do your homework. 

If, despite the risks, you are set on managing your own portfolio, then it is always sensible to spread your investment amount over a wide range of loans to lessen the risk of you losing all your capital, should one or more borrowers default on their loan repayments.

They will automatically spread your investment across different loans, based on the amount of time you wish to invest for, and the level of risk you have specified. 

Generally, the higher the risk, the higher the advertised interest rate – and thus the greatest return on your investment. 

Unless, that is, your borrowers default on their payments.

With so many variables: the amount of money you can invest, the differing level of risk with every loan, the amount of loans you can spread your money over, and the fact that you can choose to re-invest your capital when one loan ends, you will almost certainly receive a different rate of interest to the advertised one. 

The rate won’t necessarily be lower, but it’s worth remembering that the advertised rate is usually based on average returns over the period of one year.

Are there any charges involved with peer to peer lending?

Yes: peer to peer lending companies want to make a profit, and thus they charge a range of fees for their services. 

The core account management fee is usually (though not always) incorporated into the interest rate, but ongoing charges and fees differ from lender to lender. 

Always, always, check the full list of fees and charges before you choose a P2P investment, as they can really eat into your returns.

How accessible are my funds?

Some peer to peer lending accounts specify from the outset the amount of time you need to invest (typically between 1 and 5 years) in order to receive the advertised rate of interest. 

Some will also specify how long you have to wait in order to get access to your invested funds; for example, 30 days. 

Beyond these, access to your funds is largely determined by the length of the loans you invest in.

If you need to gain access to your funds before the time you specified, you may have to pay an early withdrawal fee, and usually will have to wait until the lending company can find another investor who is willing to take over your loan investment.

Do I have to pay tax on the interest?

Any interest made on peer to peer lending is subject to UK tax and will need to be declared in your annual tax return, but you do get to use your personal savings allowance (PSA) if you have one. 

Peer to peer ISA

If you would like a tax-free alternative, there is a peer to peer ISA (an Innovative Finance ISA) which works in the same way as conventional peer to peer investments, but you can use your annual ISA allowance to generate tax-free savings and will not need to declare your ISA on your tax return.

Peer to peer savings FAQ

Is my money protected in a peer to peer account?

The FSCS does not currently protect money saved in a peer to peer account, so if your supplier goes bankrupt, you could lose your entire investment. 

Some peer to peer investment suppliers have attempted to mitigate this by developing their own compensation schemes. 

However, since these do not carry the full weight of a government backed deposit protection scheme, they can be a poor substitute for statutory protection.

Can I check the risk of investing in a peer to peer account?

Most peer to peer investment suppliers offer information on their websites regarding the health of their current investment portfolio. 

Past performance cannot be used to predict the future, however. 

All peer to peer investments, by their very nature, are more speculative than government backed banks.

Can I reduce the risks associated with peer to peer lending?

Without being able to predict which investments are likely to succeed or fail, the best way to mitigate the risks associated with peer to peer investing is to split your deposits across a broad range of suppliers. 

This means you’re more likely to be exposed to a supplier who fails, but it should help prevent you from having all your eggs in one basket and losing your entire investment at once. 

Of course, if you suspect from the outset that some of your peer to peer accounts may lose money, you have to consider whether any successful investments are likely to outweigh the losses you make elsewhere. 

You might find it simpler and less stressful to place your investment in a standard (and protected) savings account.

How do peer to peer investment suppliers make money?

Most peer to peer firms offer investment and lending products. 

As such, they operate in much the same way a traditional bank would, lending savers’ deposits to borrowers at a rate of interest which is higher than they pay savers. 

The peer to peer firm, therefore, takes the difference between the two interest rates as its cut. All of their overheads: staff, technology, risk assessment, debt collection, etc. are paid for in this way.

Is peer to peer investment interest taxable?

If you have used an Innovative Finance ISA (IFISA) to invest with a peer-to-peer company, any gains will be made tax-free. 

If you have invested in a product outside of a peer to peer ISA, standard savings tax rules apply. 

Therefore, assuming your returns do not exceed your personal savings allowance, you will not pay tax. 

If your returns exceed your annual allowance, you will be taxed at the same rate as your normal income.

27 January 2021