Guide to peer-to-peer lending

What is peer-to-peer lending?

Peer-to-peer lending - also known as P2P or crowdlending - is a way to borrow money directly from individuals using an online P2P platform.

Lending and borrowing money in this way cuts out the need to go through a bank or credit union.

It connects people and small businesses who want to borrow money at lower costs with individual investors who are looking for a bigger return on their cash savings.

What are the different types of P2P lending?

P2P lending can offer investors much higher rates of interest and there are a few different types you can choose from.

The three main types of P2P lending are:

• Personal loans - You can lend money to individuals for unsecured personal loans using an online P2P platform. The borrower will be assessed using the platform's eligibility criteria. You and other lenders can select the loans to fund and invest in any that you see as a good risk.
• Business loans - Businesses will be assessed to check they’re legitimate and they usually need to provide a personal guarantee as well as financial records. The loan can help companies quickly source the funds they need to develop and grow and is repaid to you over the loan term, plus interest.
• Lending against property - With this type of P2P loan, you and other investors lend your money to property developers who repay the loan when the building is complete. The property can be used as security, so if the borrower defaults on payments it can be sold to recover some or all of the money owed.

How does it work?

Peer-to-peer lending uses an online platform to match lenders with borrowers, cutting out the need for a bank or financial institution to be involved.

This means peer-to-peer lending can provide investors and borrowers with better rates.

P2P platforms may charge an upfront fee to the borrower and/or they may earn a margin on the interest rate. They’ll detail how they make money on their website.

The way crowdlending works depends on whether you’re a lender or a borrower.

If you’re a lender

You can choose which loans you lend to or ‘invest’ in, how much you want to invest and for how long. You might also be able to choose the interest rate or return and some sites even let you bid on loans.

Higher interest rates are usually given to loans with a greater perceived risk. But spreading your money across several borrowers reduces the risk that a particular loan might not get repaid

If you’re a borrower

Your application and eligibility will be assessed in the same way as a regular loan. Your credit history will be checked, and the best deals are usually only available if you have an excellent rating.

A P2P loan can give you lower interest rates than a bank or traditional lender, but the rate you’re offered will depend on your credit score.

How much control do I have over my savings?

If you’re new to peer-to-peer lending, regulatory changes in 2019 mean that you’re not able to invest more than 10% of your investable assets.

When you do invest, the P2P platform often lets you choose the type of borrower you lend to.

You’ll typically be given information about the borrower’s perceived level of risk and, depending on the platform, you might be told what the loan is being used for.

The higher the borrower’s risk, the more interest you can charge for the money you’re providing as there’s a greater chance of not receiving it back.

At some point, you might choose to withdraw your money. Some platforms will let you do this if they can sell your loan to another investor, but others may charge you a fee or interest to access your money before the end of the term.

What are the risks of peer-to-peer lending?

There are risks to consider if you’re lending money or borrowing using a P2P loan.

For example, when borrowing for P2P business loans it’s likely you’ll have to put down a personal guarantee. This can put your assets at risk if you don’t make your repayments.

As a borrower, there’s also a risk that if you default on your payments you’ll be chased by a debt collection agency. Plus, it’s likely to negatively impact your credit score.

If you’re a lender, investing in P2P lending is much riskier than putting your money in a regular savings account.

One of the main risks is that the P2P platform could go out of business - while they’re now regulated by the FCA, this doesn’t protect you from provider insolvency.

Plus, there’s a risk that borrowers may default on their repayments, or pay their loan off early, which could reduce the rate of return you get.

To try and offset this, you’ll need to spread your money across several loans - and ideally across a number of P2P websites - to reduce the risk of suffering any major losses.

P2P lending and tax

Some peer-to-peer lenders will let you invest using an innovative finance ISA (IFISA) - commonly known as a peer-to-peer ISA.

This acts as a tax-free wrapper around your P2P loans and can help you to earn more money than you would otherwise.

When you open an IFISA, it’ll form part of your £20,000 ISA allowance for that financial year - note that you can only open and pay into one IFISA each tax year.

Your tax-free personal savings allowance is applied to the interest you get from P2P loans - so you can earn interest up to this amount each year without paying any tax.

For basic-rate taxpayers, the first £1,000 is tax-free, while the limit for higher-rate taxpayers is £500.

Organisations that can help

Although several of the larger peer-to-peer lending companies in the UK aren’t taking on new investors, there are still some that are open to lenders. This includes:

• CapitalStackers - You can choose your risk band and a minimum of £5,000 is required for investments. All loans are for property developers
• Loanpad - One of the lowest-risk P2P platforms and you can invest as little as £10. Your money is spread across the entire Loanpad portfolio of loans
• CrowdProperty - Offers IFISAs as well as being able to invest in standard lending for property developers
• Proplend - A well-established P2P platform that enables investors to lend money to commercial property investors

All P2P lenders in the UK must be regulated by the FCA. So, before you lend through a P2P platform, you should check it’s regulated - you can do this by checking the FCA register.

What’s the difference between P2P lending and crowdfunding?

Both P2P lending and crowdfunding involve a number of individuals collectively paying in money to fund the same cause or purpose.

However, the difference between them is that with P2P lending, you’re investing your money with the expectation that you’ll get it back plus interest in the long run.

On the other hand, financial donations for crowdfunding are typically used to support a venture and aren’t usually paid back.

What are the alternatives to peer-to-peer lending?

If you’re looking to grow your savings or borrow money, P2P lending might be the right option for you, but there are some other options you could consider.

Options for borrowers:

Personal loans - How much you can borrow and the interest rate you get will depend on your circumstances. If you’ve got a poor credit history, you’re more likely to be accepted for a secured loan than an unsecured one

Credit cards - If you can pay the money back during the card’s introductory interest-free period, it won’t cost you anything extra to borrow

Credit unions - If you’re struggling to be accepted for a loan from regular banks or lenders, a not-for-profit credit union loan could be a good option. Find your nearest credit union here

Options for Investors and savers:

ISAs - With all types of ISA you can earn tax-free interest and withdraw money without affecting your allowance. Whereas if you withdraw early from a P2P loan you might be charged interest

Fixed-rate bonds - Leaving your money in these accounts for a set amount of time guarantees you a fixed rate of interest - so whether rates rise or fall elsewhere, you know what you’ll get from the start

Equity crowdfunding - This is a type of crowdfunding for businesses where investors receive shares in the company in return for money. It typically uses a platform in a similar way to P2P lending