Alternative Investments – Peer-to-Peer Lending

Following our recent article on the introduction of the new Innovative Finance ISA, enabling consumers to invest some or all of their annual ISA allowance into Peer-to-Peer funding platforms, we take a closer look at what Peer-to-Peer (P2P) lending is and whether it’s worth considering as an alternative option to more traditional investment channels.

Also known as ‘crowd-lending’, Peer-to-Peer websites provide a platform for matching borrowers with lenders, with the main USP being that, with no banking intermediary, borrowers often get slightly lower rates and savers get much improved returns. The concept grew dramatically following the financial crisis, with Zopa being the first brand to launch back in 2005. The sites themselves make money via a fee for providing this ‘matchmaking’ service.

Source: (1) Ratesetter (2) Ratesetter

Whilst the concept appears to behave like a savings account with much higher returns than traditional UK offerings, with no savings guarantee they are, in reality, very much an investment, and come with all the inherent risks of investing too.

Below are the main pros and cons of investing into a crowd-lending platform.

The Pros

• Consumers are now better protected since the industry became regulated by the FCA on 1st April 2014 – firms must now present all information clearly, be upfront about the risks and have contingency plans in place for when things go wrong.
• Since April 2017, firms must have at least £50,000 worth of capital (more for larger firms) to act as a buffer to withstand financial shocks or difficulty.
• You are covered by the Personal Savings Allowance, meaning any basic-rate tax payer can earn up to £1000 per annum interest tax free and any higher-rate tax payer £500.

The Cons

• No interest is paid whilst your money is waiting to be lent out. Whilst a few thousand pounds should be invested fairly quickly, large amounts can take longer so it would be wise to drip feed the money in – after all, the money is better sat in your account than theirs whilst it waits to be invested.
• Unlike the £85,000 compensation cover UK savers receive from the Financial Services Compensation Scheme should their financial institution go bust, Peer-to-Peer lenders have no such cover.
• Each site has its own way to mitigate risk so check carefully before choosing which platform to use.
• The risks are rising – when Zopa first launched, it only offered loans to 0.5% of applicants; it now lends to 20%, more in line with the approval rates of traditional high street banks.

As crowd-lending has grown in popularity, several new providers have entered the market – see links at the end of this article. However, three key players have dominated the industry, holding two-thirds of market share between them. The key difference between them is how they mitigate your risks as a lender – the greater the risk, the high the return, and vice versa.

Funding Circle
With £80m invested by the UK Government, Funding Circle is the purest Peer-to-Peer system lending to businesses. All investors must use their auto-bid system, whether they choose the Balanced option, which lends to businesses across the full risk rating spectrum, or the Conservative option, which only lends to the two lowest risk classes of businesses, meaning both returns and risks are lower than the Balanced option. Whichever option you choose, no more than £100 and no more than 0.5% (min £20) of your money will be leant to any one single business. All loans are repaid on a monthly basis and debts can be sold to other investors on the secondary market should you wish to access your money early.

Zopa
The first P2P lender to launch, Zopa began with just £1.5m in loans back in 2005, rising to £3.2bn in 2016. In 2013 Zopa changed the way it worked, offering investors a fixed rate of interest depending on how much money they wanted commit and for how long. Like Funding Circle, Zopa offers two products, both of which spread your money into £10 mini-loans across various borrowers; Core lends to borrowers with a risk rating of A* to C (the lower end of the risk spectrum) and has a projected annual return of 3.9% after fees and bad debts with a 1% fee for withdrawing early, whilst Plus offers higher projected returns of 6.9% but lends to borrowers across the full risk rating spectrum making it a riskier choice.
Until June 2017, Zopa also had a Safeguard fund in place, which meant that if a borrower failed to repay their loans, an investor would still get their money back. This has now been withdrawn. Again, returns are re-paid monthly and can either be withdrawn or re-loaned out to another business. Early withdrawal of your money will be subject to a 1% fee.

Ratesetter
As of August 2017, Ratesetter is no longer a member of the Peer-to-Peer Finance Association, as it breached the trade body’s transparency rules. However, before it withdrew, it operated in a similar way to Zopa except that, rather than offering fixed rates of return, investors could choose to customise their rates of interest depending on how long they were willing to wait for their money to be lent out.
Ratesetter also had its own version of Zopa’s Safehuard fund, called a Provision Fund, which protected the rate investors were given when they put their money in. To date, the fund stood at £20.5m. For early withdrawal, investors could use its ‘Sell-Out’ function, but this was subject to a fee which averaged at a much higher rate of 2.51%.

As mentioned earlier, whilst these are the three biggest lenders, they aren’t the only ones in the market. Other members of the Peer-to-Peer Finance Association include ThinCats, MarketInvoice, Lending Works, Landbay and Folk2Folk.

For more information about investing in Peer-to-Peer lending, please speak to your Finura Partners adviser.

Capital at risk; investments and the income from them can fall as well as rise.

Sources: https://www.moneysavingexpert.com/savings/peer-to-peer-lending
http://www.telegraph.co.uk/money/special-reports/can-still-profit-peer-to-peer-lending/