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A Complete Guide To Peer-to-Peer Lending

Peer-to-peer lending is a non-traditional form of investment. Despite that, it has gained significant popularity in recent years. In fact, the peer-to-peer lending market in the UK alone, is around £2.2 billion. 

This form of lending offers investors with a low-risk opportunity to invest their savings and expect a good return. 

The following guide deeply elaborates on peer-to-peer lending, the best platforms for it, as well as the risks involved with the approach. 

What is meant by peer-to-peer lending?

investment

Before learning about peer-to-peer lending advantages and disadvantages, the first thing you need to understand is what peer-to-peer lending actually is. 

P2P lending platforms enable individuals to invest their income to earn interest. The process is carried out through a peer-to-peer lending platform, which allows investors to search for the right investment opportunity. 

One of the most important reasons why peer-to-peer lending has gained popularity is the absence of a bank. When a bank is removed from the equation, you, as an investor, can cut the cost of paying the bank fee, along with other charges. 

However, in addition to benefiting the investors and the company you have invested in, peer-to-peer lending also has a positive effect on the economy. This is because the money is invested in credible individuals, businesses or property developers. 

Essentially, P2P lending provides solutions to two primary issues. Firstly, it allows private investors to profit off of the returns. Whereas, it also enables borrowers to benefit from the financial funds required to grow their business. 

P2P lending vs. Crowdfunding 

Peer-to-peer lending is often confused with crowdfunding. However, there is a vast difference between the two.  In crowdfunding, financial rewards are given to an entity or an individual to raise money for a specific cause. The primary objective of crowdfunding is to collect enough money to fund a project.

On the other hand, in peer-to-peer lending, the money is raised to fund a project, however, the investor is able to collect the money back with interest, quite similar to giving out a loan. In crowdfunding, there is no discussion about the % returns, except in the case of real estate crowdfunding. 

P2P lending vs Crypto lending

Crypto lending falls into the category of peer-to-peer lending, however, this form of investment takes place using cryptocurrencies instead of monetary assets. Additionally, the interest rates in crypto lending are relatively lower than in traditional P2P lending. With that said, the risk in this approach is also reduced, as cryptocurrencies are exchanged instead of financial assets. 

P2P lending vs Real Estate Crowdfunding 

Real Estate crowdfunding is an approach where an investor can purchase a property and become a shareholder with other investors. While the investment required for this approach is low, it also has inconsistent returns. 

When compared with P2P lending, real estate crowdfunding provides lower returns (3% to 7%), whereas you can easily benefit from a uniform return rate of 10% to 15% with P2P investment opportunities. 

P2P lending vs bank savings 

Bank savings fail to provide the same benefit they used to. Now, if you leave a large sum of money in bank savings accounts for a longer duration of time, it is highly likely that you end up losing your monetary funds due to inflation and the increasing cost of living. Therefore, using a savings account for short-term investment can be advantageous, however, for long-term investments, P2P lending can be a better option.

P2P lending vs company bonds

Investing in a company bond is a risky option. This is because if the firm fails to meet its financial objectives, you would end up losing money. In such scenarios, bond investors end up losing their capital. Additionally, company bonds fail to provide a high return rate. With a company bond, you can only benefit from a 3% to 7% return rate, which is lesser than P2P lending. 

You can still invest in FCA regulated firms via P2P platforms to earn higher revenue, without taking a greater risk. 

P2P lending vs stocks 

Investing in stocks always comes with risk. However, stocks are ideal for long-term investment. If you are interested in seeing quicker returns, peer-to-peer lending can be the ideal choice. 

Why is peer-to-peer lending popular?

two men in suit sitting on sofa

Peer-to-peer lending follows a simple procedure. As a lender, you invest your money by making a payment through a debit card or via direct transfer. You also have the opportunity to set the interest rate that appeals to you or agree with the existing interest rate offered by the platform. 

Essentially, there is a fixed period of duration for the investment process. For instance, you can invest in a business for a three to five years period. 

There are numerous advantages to participating in P2P lending. Here are a few factors that make peer-to-peer lending an attractive option for investors. 

Adequate Returns: With P2P lending, you can benefit from greater and better returns, in contrast to other high-risk investments. 

Low Minimal Investment: If you are looking to invest on a budget, P2P is an ideal approach. 

Combat Inflation: With P2P lending, the rate of returns is much higher than the rate of inflation. 

Reduced Risk: This approach comes with reduced risk, as your money goes to credible borrowers. Most peer-to-peer lending platforms have a rejection rate (for borrowers) of approximately 80%, which shows that only the most reliable parties are invested in. 

Versatility in Risks: This approach enables investors to choose the level of risk they are comfortable with. 

Asset Diversification: With peer-to-peer lending, your investment portfolio is diversified, as the money can be invested in different subdivisions, such as firms, real estate and consumer markets. 

Security:  Peer-to-peer lending has a reduced correlation with the stock market. Hence, an increase or decrease in the value of equity markets does not affect the P2P holding. 

Asset Liquidity:  One of the major advantages of this investment is that you have the power to decide the amount of time you wish to invest for. You can access your financial assets, as quickly or late as possible, depending on the type and term of loan given out. 

What is the return offered by these investments? 

The amount you earn from a peer-to-peer platform can vary depending on the type of investment you make. Essentially, if you have put in your money to fund an individual project, or a person with a promising credit score, a yield of 4% to 5% can be expected on an annual basis. 

On the other hand, if you wish to benefit from a higher yield, giving out loans to property developers, using a P2P platform, can provide a return of 6% to 9% annually. 

Similarly, if you invest in small businesses, a yield of 9% to 15% can be expected. 

The amount of return that a loan provides majorly depends upon the degree of risk involved. High-risk loans offer a higher return, whereas low-risk loans come with a relatively lower return rate. 

What are the risks involved in peer-to-peer lending?

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Peer-to-peer lending does have certain risks that you need to look out for. Here are a few drawbacks of using these platforms.

Defaulting: Defaulting is referred to the situation in which the party you have lent the money to is unable to pay it back. As there are no banks involved in the process, the money invested via a P2P platform, it is not covered by the FSC (Financial Services Compensation) Scheme. Although, if you choose the right peer-to-peer lending platform, you can benefit from contingency or provision funds that can cover the loss if the borrower defaults.  Considering this, it is important to comprehensively research the platforms before investing. 

Receiving Untimely Payments: Oftentimes, with P2P lending, it is possible that your loan is repaid earlier or later than what you had planned for. In such situations, the interest earned may be less than expected. 

Choosing the wrong P2P platform: You can place yourself at a loss by selecting an unreliable platform. If in the unfortunate case, the P2P platform experiences bankruptcy, you can suffer a loss. Taking this into consideration, it is essential to select a P2P lending platform that is regulated by the FCA (Financial Conduct Authority). Platforms regulated by the FCA are obligated to store the lender’s investment in ring-fenced accounts, which are segregated from their own. 

What is the top peer-to-peer lending websites?

There are various peer-to-peer lending platforms available for investors today. However, before placing your money at risk, make sure to research the platforms thoroughly. 

If you are looking for reliable peer-to-peer lending sites, you can check out the following top-rated P2P platforms available for investors. 

  1. RateSetter
  2. Zopa
  3. Funding Circle 

RateSetter

RateSetter is one of the most popular platforms for P2P lending. With this, you do not have to have a large sum of money that you need to put forward. In fact, the minimal amount to lend with RateSetter is £10. 

Essentially, the primary reason that RateSetter has gained popularity is that it offers you a Provision Fund. This means, if your borrower defaults, the loan amount would be reimbursed by the platform. 

With that said, there is no guarantee that the complete investment amount would be returned to you if the borrower defaults. Instead, the platform would only return you with half of all of the money, depending on the amount that is present in the Provision Fund at the time.  

Essentially, the Provision Fund is also accumulated by cutting a percentage of interest from the repayments. 

Due to the COVID-19 pandemic, RateSetter is taking extra measures to increase the provision fund. Hence, 50% of the total interest is expected to be directed towards the Provision Fund until the end of the year. 

RateSetter allows you to customise the investment. You also have the opportunity to reinvest the earned interest and take advantage of the compounding. As of now, it offers three different rates, which include Access (3%), Plus (3.5%) and Max (4%). 

Additionally, there is no additional fee that you have to pay to get started. 

One drawback of RateSetter is that you do not have the command over choosing the entity for investment. Once you transfer your money, the funds would be transferred to a loan contract that is matched with your account. 

If you wish to withdraw the investment before the set time period, a certain amount of fee would be payable. For the access plan, there is no release fee, whereas the Plus plan has a release fee of 30 days’ worth of interest. Similarly, the Max plan charges a fee that equates to 90 days’ worth of interest.

With RateSetter, you are provided with the opportunity to use the Access, Plus and Max plan in the form of Innovative Finance ISA (IFISA). This option enables you to earn tax-free interest on your investment, with some limitations, which are discussed below in detail. However, RateSetter is not FSCS approved. 

In the case that your investment is not made via the IFISA, it would be required to declare the earnings for tax. 

Zopa

Another popular platform for P2P lending is Zopa. In fact, it is one of the first websites that facilitated peer-to-peer lending. 

It presents investors with two plans, which are Zopa Core (2% to 4%) and Zopa Plus (2.1% to 5.3%).

Unlike RateSetter, Zopa has a larger fund requirement for investors. If you wish to invest, a minimum amount of £1,000 would be required. Therefore, if you are unable to spare this portion from your income, choosing a different platform might be more advantageous. 

Zopa is a P2P platform that also offers a partial contingency for your investment. Once you make the payment, your amount is divided and sent to a number of different borrowers. As a result, your money is diversified and not completely placed at risk. For instance, if one of the borrower’s defaults, your entire investment would not be compromised. 

Moreover, each entity that is provided with your money has a different rate. As a result, the payments would be made on a monthly basis, on different dates. Parallel to RateSetter, you have the option to reinvest your income to accumulate a larger profit. However, if you do not wish to select this option, the interest would stay in your account and can be withdrawn at any time, without any additional charges. 

In the case you wish to withdraw the investment before the pre-decided period, a fee of 1% would be charged. 

Essentially, Zopa also enables you to benefit from the Innovative Finance ISA. However, it is also not covered by the FSCS.

Funding Circle 

If you wish to find a peer-to-peer lending platform that primarily lends to businesses, Funding Circle would be the ideal choice. 

Just like Zopa, Funding Circle also has a large requirement for the investment amount, which is £1,000. However, with this P2P platform, the return rate is relatively higher, as you can expect a return rate of 4.5% – 6.5% on an annual basis.

Funding Circle presents investors with two different options. With their Conservative plan, you can place your money in a lower-risk business, however, the return rate would also be less. On the other hand, you can also lend to a business with varying risk and expect a higher return on your investment. 

Funding Circle only gives loans to businesses; therefore, it provides investors with the knowledge of the amount of risk they can take with their investments. Each firm is presented with a label, which tells you the degree of risk involved with the loan. Additionally, the duration of the loan is also predefined, which ultimately sets the amount for the interest. 

Funding Circle also protects your financial assets by presenting the opportunity of dividing your investment among various businesses. This way, if one business fails to return the loan, all of your investment would not be lost. 

With this peer-to-peer lending platform, you also have the opportunity to either reinvest your generated income or withdraw the repayment, as it arrives. You can also sell your investment to other lenders, however, in doing so, a fee of 1.25% of the total sale amount would be charged as a transfer payment. 

In addition to the aforementioned, there are several other peer-to-peer platforms that you can benefit from. However, it is recommended to choose well-established facilities in order to avoid the risk of platform bankruptcy. 

Are you required to pay tax on the returned income?

Tax, Forms, Income, Business, Paperwork, Finance

One of the major questions that investors have is whether or not the income generated by the peer-to-peer lending platforms is taxable. 

Fundamentally, the amount of money you generate with your investments would be classified as an income, thereby making it taxable. However, you may not have to pay any tax in the case that your income falls in the range of the personal savings allowance. 

Personal savings allowance is a facility that enables basic rate taxpayers to earn up to £1,000 of tax-free interest. The same regulations are applied to higher rate taxpayers; however, the allowance amount is reduced to £500. If you earn interest that falls in a range above the allowance amount, it is paid at your highest marginal rate of tax. 

However, with Innovative Finance ISA (IFISA), you can receive interest from P2P loans tax-free and refrain from paying tax on capital gains, unless you are participating in a large investment. The Innovative Finance ISA (IFISA) requires the peer-to-peer loans to be stored in an individual savings account. 

With that said, the IFISA only allows you to lend up to a limited amount of £20,000 per tax year. Additionally, this allowance is divided among the various types of ISA, which includes IFISAs, cash ISAs, lifetime ISAs, and stocks and shares ISAs.

In this situation, you would not be required to declare any ISA interest, income or capital gains to HM Revenue & Customs on any amount of profit in an IFISA.

Can you claim tax relief on unpaid loans? 

It is possible to claim tax relief on unpaid loans, only in the situation that you are generating an income amount that requires you to be paying tax on the interest in the first place. 

However, you can only make a claim with complete clarity that the loan is not going repaid in full. If the payment is late, your claim would not be considered. 

To claim tax relief, the loss can be set against the other interests earned from a P2P loan, prior to when your total income is taxed. 

Conclusion- Is it right for you?

Peer-to-peer lending is a recent trend in the world of investing. It enables investors to eliminate the need for a bank or middlemen while placing their money in the business, real estate or an individual borrower. With P2P, interest is earned on the loaned amount. Peer-to-peer lending is ideal for investors who have a low investment budget, and those who do not wish to take a great risk with their financial assets. 

P2P lending provides investors with a good rate of return, flexibility in investment options and duration, liquidity of assets, as well as diversification of the investment portfolio. With that said, it does have certain risks. You may suffer a loss if the platform you are using experiences bankruptcy. Additionally, there is also a risk of default with P2P lending, as the money is not covered by a bank. 

Taking that into consideration, it is imperative to thoroughly research the peer-to-peer lending platforms and choose a dependable option, so the foregoing risks can be avoided. It is extremely important to select a peer-to-peer platform that is regulated by the Financial Conduct Authority. 

You can read the aforementioned reviews of some of the best peer-to-peer platforms before making a decision about your investment. 

 

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