Peer-to-peer lending has soared in popularity in recent years as a way for savers to generate inflation-beating returns, but many people are still in the dark as to how it actually works.
Here, we explain what you need to know.
What is peer-to-peer lending?
As its name suggests, peer-to-peer lending involves individuals lending direct to other individuals or businesses, rather than going through a bank or building society. The idea is that as there’s no middleman involved, lenders can offer more competitive loan rates, and the interest they’ll receive from borrowers is higher than the returns they could earn by keeping their money in a deposit account.
How do I go about becoming a peer-to-peer lender?
There are several different peer-to-peer lending websites which help match borrowers to lenders. These include Wellesley & Co, Lending Works, Assetz Capital, RateSetter, Zopa. Borrowers are carefully vetted by these websites and only those who are considered unlikely to default on their loans will be accepted. If you want to be a lender, you need to consider how much you are prepared to lend, over what period of time, and what sort of returns you are looking for. Rates are typically pre-set. Often your investment will be split up across several different borrowers so that if one of them fails to keep up with repayments, the financial effect on you won’t be as great is if you’d lent to them alone.
Do I have to pay tax on returns from peer-to-peer lending?
Under Personal Savings Allowance rules, which were introduced in April 2016, the first £1,000 in interest from your savings, including returns from peer-to-peer lending, is tax-free if you’re a basic rate taxpayer. This falls to £500 if you’re a higher rate taxpayer. Additional rate taxpayers who pay tax at 45% don’t get a Personal Savings Allowance. However, it is possible to shelter all your returns from tax by holding your peer-to-peer investments in what’s known as an Innovative Financial individual savings account (ISA). An ISA is essentially a tax-efficient wrapper and this tax year (2017-18) the total amount you can save into ISAs is £20,000.
Is peer-to-peer lending riskier than putting my money into a savings account?
Yes, because when you save with a bank or building society, the first £85,000 of savings per person per banking licence is protected by the Financial Services Compensation Scheme (FSCS). That means if the bank of building society you save with runs into financial difficulties, you won’t lose your savings. Peer-to-peer lending isn’t covered by the FSCS, so if something goes wrong, there’s a risk you could end up out of pocket. However, peer-to-peer websites do have to have a financial buffer in place and they are regulated by the Financial Conduct Authority (FCA) which means they have to follow certain guidelines which protect consumers. Most also have their own ‘provision funds’ in place too so that lenders will be reimbursed if a borrower doesn’t pay back what they owe.