With the top paying savings accounts and cash ISAs struggling to offer attractive returns, peer-to-peer lending accounts are becoming increasingly popular with savers fed up with low interest rates. Peer-to-peer lending sites can offer an alternative to traditional banking and can have the potential to achieve a better rate of interest. Investing your savings in a peer to peer lending scheme can offer better returns than more conventional forms of savings however there are risks, such as your funds not being covered by the Financial Services Compensation Scheme (FSCS).
What is peer to peer lending?
In simple terms, peer to peer lenders match people who want to earn interest on their savings with people who want to borrow money. The advantage of this arrangements is that both savers and borrowers can benefit from interest rates that are better than those found on the high street, whether from conventional savings accounts or from bank loans.
How does peer to peer lending work?
Investors can register with a peer to peer lender, and will usually be offered the choice of how long to commit their money for – for example, some peer to per lenders offer different interest rates in return for locking your cash away for one, two or five years. Your money is then matched with people who want a loan for the same time period.
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Why do peer to peer lenders offer better rates?
Peer-to-peer lenders can often be in a position to offer better rates than banks to both savers and borrowers alike because they have fewer costs than traditional banks. For instance, they have no high street branches to pay for. These savings can then be passed on to the people participating in the peer to peer lending process in the form of better rates.
Benefits and features
Apart from the clear attraction of being able to earn better interest on your money than is currently on offer from conventional savings rates and ISAs, there are other beneficial features of peer to peer lending, such as:
- Peer to peer lending has been regulated by the Financial Conduct Authority (FCA) since 1st April 2014.
- Unlike a fixed rate savings account, you can invest in peer to peer lending schemes from as little as £10 – it can be a good idea to start with a small amount in order to see whether peer to peer investments are right for you, before committing a larger sum of money.
- You can choose how to lend money based on the length of investment and the level of risk involved.
- Some peer to peer accounts offer you the option of receiving monthly or annual interest.
Potential drawbacks
Before you consider whether peer to peer investing is right for you, it is essential to be fully aware of the differences between this type of account and standard bank or building society savings accounts:
- Money held in peer to peer savings will not be covered by the Financial Services Compensation Scheme.
- Investing your savings within a peer to peer account can mean interest rates vary significantly – generally speaking higher risk borrowers will get higher returns, so if you are prepared to lend to people with lower credit scores you may be eligible for a higher interest rate. But this raises the risk that you may not get some or all of your money back.
- You may be required to pay a service charge, typically around 1% per year.
- If you need to withdraw your funds early, you may incur a fee.
- If the borrower chooses to repay their loan early your rate of return may be affected.
- Peer to peer interest rates are advertised gross, so you will need to take this into consideration as you will need to pay income tax on any returns you make. Peer to peer holdings cannot currently be included in ISAs, although there are indications that this may change in the future.
How can I get started with peer to peer investing?
To lend and save via a peer to peer scheme you will usually need to be:
- Aged 18 or over
- A UK resident
- In possession of a UK current account
- Prepared to invest for a set period of time in most cases
A growing peer to peer market
As the peer to peer market grows, many peer to peer lending companies are bringing in increased measures to cover lenders in the event of default from the borrower. For example, Lending Works now offers a Reserve Fund to cover missed loan repayments. However, it is important to note that these measures are not the same as the protection available from the FSCS offered by a traditional bank or building society and that peer to peer lending puts your capital is at risk.
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Peer to peer savings accounts are not the same as normal savings accounts so you need to consider the features before you invest. No news, feature or comment should be seen as a personal recommendation to invest. If you are in any doubt as to the suitability of a particular investment you should seek independent financial advice.
