Peer to Peer Lending: A Great Way to Increase Your Savings?featured

For a while now I’ve been meaning to write a blog post about the world of peer-to-peer lending (P2P) and how it can help savers boost the return on the cash they tuck away. It’s worth noting that I’ve never used a P2P service myself before, but I’ve read countless articles that suggest it can be an ideal money-grower if you’re willing to lock away your cash for a set period of time. So today I’m featuring a guest post from Lending Works, looking at the benefits of P2P while also addressing the risks involved.

It’s an investment option the masses may be unfamiliar with, but peer-to-peer lending (P2P) has nonetheless enjoyed a meteoric rise over the last 18 months in the UK. This very simple concept involves creating a platform for ordinary people to lend their money directly to fellow consumers in need of a loan, and, by virtue of the monthly repayments these borrowers make, the lender enjoys a return on their money of up to 6% per annum.

What is peer to peer lending?

P2P offers a timely and refreshing alternative to poor value interest rates currently associated with many traditional savings accounts. Even the advent of cash ISAs are typically unable to push returns on savings anything beyond 2%. In the essence of transacting, peer-to-peer platforms aren’t a whole lot different from banks and other beacons of the high street. Some customers put money into the institution, while others draw it out for the purposes of credit.

The difference with peer-to-peer lending is that the process is a whole lot more streamlined, given that the money from the lender is matched directly with the borrower, without the platform taking an unreasonable margin in between. In addition, the process is conducted entirely online, eliminating the need for intermediaries and overheads almost entirely (the platform simply acts as a mediator, and ensures proper controls are in place). This all generates tremendous value in the equation; value that both lender and borrower benefit from in spades.

Is P2P a risky investment?

One important caveat to consider is that, unlike a savings account, peer-to-peer loans are not covered by the Financial Services Compensation Scheme (which will cover savers up to £75,000 per institution from January 2016) in the event of borrower default and/or platform failure, and lender capital is therefore at risk.

However, platforms have numerous measures in place to counter such risks. First and foremost, loan applicants are put through a meticulous test for creditworthiness, ensuring that those with poor credit scores won’t be allowed through the door. Funds are also spread across numerous borrowers in order to diversify risk. Lending Works in particular has taken safety a step further, by orchestrating an insurance which, over and above the aforementioned measures, covers lenders in the event of borrowers defaulting due to reasons like unemployment, sickness, accident, death, or even darker forces such as fraud and cybercrime.

It is an industry which has been stress tested too, given that default rates during the global economic recession typically remained between 2-5%, the sort of figures which were well covered by the respective reserve funds.

In addition, P2P lending will now be regulated by the FCA, ensuring that they adhere and are answerable to the highest possible operating standards and regulations.

A new type of ISA

Perhaps the biggest breakthrough for the sector and its investors is the impending inclusion of peer-to-peer lending within ISAs. In July, the Chancellor confirmed a new wrapper, known as the Innovative Finance ISA (IFISA), will be going live on 6th April 2016, and that peer-to-peer loans will form an integral part of it. This means that lenders will be able to make P2P loans up to the ISA allowance threshold within their IFISA account each year, and benefit from tax-free returns on the interest paid by borrowers.

Experts predict that inclusion within ISAs will see the industry swell dramatically from £3 billion to £50 billion within the next couple of years. And, as a bonus, lenders will enjoy an additional tax efficiency by way of the Personal Savings Allowance, meaning up to the first £1,000 in interest received on your P2P investment will be removed from income tax (dependent upon which tax bracket you fall into).

Is it right for me?

It’s important that prospective lenders do their homework, and ensure they study the ins and outs of each platform. After all, there is an element of risk with P2P, and it is vital that you are comfortable taking this on board before making an investment. What’s more, such an option should be a means of diversifying your portfolio, and bundling all of your money into it would be ill-advised.

However, the merits of the sector certainly make a strong case, especially in these times of low base rates and derisory returns on savings. Peer-to-peer lending offers an ideal midpoint for those fed up with poor returns, but not willing to accept the risks posed by putting money into stocks and shares.

Investment is a personal choice, and everyone has a different risk appetite, and different perceptions of risk and reward. But as peer-to-peer lending continues to make the shift from ‘alternative’ to the mainstream, it certainly appears to be something worth considering.