As a pretty new way of borrowing and investing money, peer to peer lending (P2P) is increasingly popular. Here are the best P2P lending firms to use, plus the risks to know first…
Peer to peer lending certainly has its perks (not least the great interest rates on your investments) but it’s not without risk.
To clarify some of the confusion around P2P lending, we’ve put together the key facts about how it works, the risks involved and the best lending platforms to use.
So, if you are keen to try peer to peer lending to either borrow or invest money, read on for the info you need to get started.
What is peer to peer lending?
As the name suggests, peer to peer loans are lent by people to other individuals or businesses (i.e. from one peer to another).
The money is lent via lending companies, which manage the loan distribution and repayment process.
Borrowing P2P loans can seem tempting at first glance. The lending platforms generally offer a wide range of loan amounts with competitive rates. While they can help in some situations, we’d urge you to consider your other, lower-risk options first – particularly the government’s Student Loan.
Also, lending money through peer to peer firms can see you earning a fair amount of interest on the money you invest. When done carefully, there’s the potential for you to make more money than you would if you used a savings account. But, bigger interest rates come with bigger risks.
* Ratesetter’s annual rates for the rest of 2020 are down to 1.5% – 2% because they have implemented a Temporary Interest Reduction period.
Risks of peer to peer lending
Whether borrowing or lending money through P2P lending, there are risks involved. Here are the key things to bear in mind:
Borrowing money through peer to peer loan sites
As is the case when taking out any type of loan, it’s important to think things through carefully and make sure it’s really the best option for you.
In particular, the main risks involved in borrowing a peer to peer loan are:
- Inflexible repayment amounts – It’s unlikely you’ll be able to change your monthly repayment amounts so you’ll need to be confident you can afford each repayment before making any commitments.
- Hard credit check – Taking out a loan requires a hard credit check which leaves a mark on your credit score report. Having too many hard credit checks (particularly over a short period of time) affects your credit score and can harm your chances of getting credit in future.
- Missed repayments – If you fall behind on repayments, your credit score will take a hit and there’s a chance you could have the funds reclaimed by debt collectors.
If you have any doubt that you might not be able to make each repayment in full and on time, we’d urge you not to take out the loan.
As well as this, think about whether taking out a P2P loan would lead you to have too many hard credit checks within a short period. If you think that it might, try to find a different source of funding that won’t impact your credit score.
It’s worth noting that you’ll face similar risks with most loans from credit lenders. However, you won’t find these risks with the government’s Student Loan, which you’ll stop repaying anytime your income falls below a certain amount. Plus, you won’t undergo a hard credit check when applying for a Student Loan.
Even if you’re confident you can manage the risks, we’d still encourage you to look into your alternative funding options before taking out a peer to peer loan – you might be surprised by how much funding is available to you elsewhere for no or minimal risk.
Lending money through peer to peer loan platforms
Lending money in the form of peer to peer loans can be a great way to make money as, if it pays off, you’ll earn your cash back plus interest. But remember that investors face more risks than borrowers.
Here are the main risks involved in lending money as a peer to peer loan:
- Losing money – Any investment you make through P2P lending relies on other people paying back the loans for you to make money, or even get all of your money back. If you do invest, find loan firms that try to repay you if borrowers miss payments like Ratesetter.
- No FSCS protection – You won’t be covered by the Financial Services Compensation Scheme (FSCS) as you would usually with savings accounts. FSCS would cover you for up to £85,000 if it applied here, but as it doesn’t, your P2P investment wouldn’t have the same level of protection as your savings.
- Uncertain economy – P2P lending is a relatively new industry, so loan companies could struggle to survive in the current climate (affected by the coronavirus pandemic and Brexit). It may also be harder for some borrowers to keep up with repayments.
- Slow return on investment – There’s a chance that the money you invest through P2P loan firms won’t be lent out straight away as there can be a wait before your money is matched to borrowers. Because of this, it’s not guaranteed that you will start earning interest immediately.
- Difficult to withdraw investments early – We’d strongly advise against investing in P2P loans if there’s a chance you’ll need the money back early. Some lending platforms are more flexible than others, but you may be charged a fee to release the funds before repayments are due.
Like with any form of investment, it can definitely be worth doing if you’re confident you can manage the risks – but you should never invest more money than you can afford to lose.
Peer to peer lending site reviews
You can invest a minimum of £10 through Ratesetter.
One major benefit of investing through Ratesetter is that they have a Provision Fund with the aim of reimbursing you if a borrower misses a repayment.
But please note, it is not guaranteed that you’ll get back all of the money back that you lose – whether they can repay some or all of the lost money is based on how much is in the Provision Fund at the time. To build up the fund, they contribute a cut of interest from repayments towards it.
They’re currently halving the amount of interest investors are receiving because, in response to the COVID-19 outbreak, they’re putting the other 50% of interest towards the Provision Fund for the rest of the year.
Here are three products offered by Ratesetter to investors:
- Access (3%*)
- Plus (3.5%*)
- Max (4%*).
* Ratesetter currently have a Temporary Interest Reduction period, so if your interest is matched at the rates above (i.e. 3%, 3.5% or 4%), the interest will be reduced by 50%.
When you invest money, your funds will automatically get matched to a loan contract – you do not choose who borrows the money.
When looking to withdraw your funds, the Access plan has no fee to release investment, Plus has a release fee of 30 days’ worth of interest, and Max has a release fee of 90 days’ worth of interest.
Ratesetter give you the option to take out their Access, Plus or Max products in the form of an Innovative Finance ISA. This would allow you to earn tax-free interest on your investments, but it’s worth noting that it still doesn’t have FSCS protection.
If you choose not to invest through an Innovative Finance ISA, you will need to declare your investment earnings for tax – we go into more detail about this below.
Personal loans from Ratesetter have interest rates from 3.9%. The loans range from £3,000 to £25,000 over one to five years.
Their website has the example of a loan with 14.4% APR Representative (fixed). Based on this, if you were to borrow £3,000 over three years at an interest rate of 9.2% per annum (fixed) with an added fee of £195, you’d have monthly repayments of £101.85. Altogether, you’d repay a total of £3,666.51.
Wondering why the APR and interest rates are different? APR means the Annual Percentage Rate, and it includes the interest plus any added fees, such as annual fees and ones for applying. We explain APR in more detail in our guide to understanding banking jargon.
Fees vary, but on average borrowers will be charged 7% in fees.
As with all P2P loans, people are assessed by Ratesetter before being accepted or rejected for a loan. The company decides whether or not to accept loan applications based on whether they think the applicant can afford repayments, as well as their ‘creditworthiness’ (track record with credit).
As well as personal loans, Ratesetter also offer ones for property developers and used-vehicle dealers. You can find more info about these on their website.
Note: You must be 21 or over to be eligible for the loans.
Zopa is the longest-running P2P lending site. These are the two main product types they offer to investors:
- Zopa Core (3.4% – 5%)
- Zopa Plus (4% – 6%).
For these products, you’d need to invest a minimum of £1,000. This is obviously a big investment, so don’t lend the money if you can’t afford to lose it. Please also consider lower-risk ways to earn interest, like putting the money into a savings account.
If you decide you can afford this investment and you’re confident you can manage the risks, any money you invest through Zopa would be split up and lent to a number of borrowers. Because of this, if a borrower is unable to repay their loan, it will only impact a small part of your total investment, so any loss should be minimised.
Each borrower has a different rate and will make their monthly repayments on different days.
And, as the repayments come in, you have the option to automatically reinvest the money to allow you to earn greater interest. But, if you choose to keep the monthly repayments, they’ll stay in your account and you can withdraw them at any time for free.
If you decide to take back your money before borrowers’ repayments are due, you can sell the remaining amount of lent money to other investors for a 1% fee.
It’s also worth checking out Zopa’s Innovative Finance ISA which, again, offers you tax-free interest, but bear in mind that it’s not covered by the FSCS.
Zopa offer personal loans and car loans from £1,000 to £25,000 over one to five years. Rates vary, but their website gives examples of loans from 8.7% – 17% APR (remember, APR is the interest rate plus fees).
An example on their site is for a loan of £10,000 over five years with a rate of 17% APR Representative. It would have an interest rate of 12% (fixed) and monthly repayments of £242.32. After five years, the total credit would be £11,040 (including interest and a £1,040 fee).
The fee and interest rate you’re charged will be calculated based on your individual circumstances.
Zopa are very selective about who they offer loans to – on their site, they say that only about 20% of people who apply for a loan through them are accepted.
Note: You must be 20 or over to apply for their loans.
On Funding Circle, there is a minimum investment amount of £1,000. Again, this is a significant amount of money, so as we mentioned with Zopa, we would urge you to never invest money you can’t afford to lose.
When investing through this lending platform, you can earn between 4.5% – 6.5% each year. They have two lending options:
- Conservative (lending to lower-risk businesses for a lower return)
- Balanced (lending to businesses of varying risk for a higher projected return).
Funding Circle only offer loans to businesses, and each company they approve for loans are placed in a ‘risk band’. The risk band, combined with the length of time they need the loan for, determines how much interest they pay.
As we’d mentioned with Zopa, on Funding Circle, you can spread your funding across a number of loans to minimise how much you’d lose if a business can’t keep up with repayments.
You can either withdraw repayments as they come in, or reinvest them straight back into further loans to earn more interest.
And, if you decide to sell your investment to other lenders to get your money back before repayments are due, a 1.25% transfer payment will be taken from the total sale amount.
Funding Circle only give out loans to businesses, and they’re currently offering loans of up to £250,000 through the government’s Coronavirus Business Interruption Loan Scheme (CBILS).
Additional peer to peer lending companies
Because of the risks, we recommend using the more established P2P companies if you do decide to borrow or lend money this way.
Smaller P2P firms may be more at risk of struggling with the economic climate. Plus, they might also have fewer measures in place to repay investors if borrowers are unable to keep up with the repayments.
However, that being said, different peer to peer lending firms offer different types of loans at different rates, so there may be others besides Ratesetter, Zopa and Funding Circle that suit you better.
As long as you’re careful to minimise your risk of losing money (and only invest money you can afford to lose), it might still be worth looking into smaller firms. But, to reduce risk as much as possible, we would still recommend using a bigger P2P firm, like the ones listed above.
Examples of alternative P2P lending platforms
Do you need to pay tax on your investment income?
Some peer to peer lending firms give you the chance to invest through an ISA – any interest you earn through these is tax-free.
But, if you don’t invest through an ISA, you will need to declare your interest for tax.
If your total income (including a salary and any interest you’ve earned) is below £12,500, you won’t need to pay any tax at all because this falls below the Personal Allowance amount.
As well as the Personal Allowance, if you’re earning below £17,500, the interest you earn is covered by a starting rate for savers of up to £5,000. This means that if you earn between £12,500 and £17,500, you still don’t need to pay tax on the interest from your investments.
Better yet, the first £1,000 of interest you earn is tax-free.
So, it’s not until you’re earning above £18,500 (salary and interest combined) that you’ll start paying tax on the interest you’ve earned.
Still not sure if you need to pay tax? See our guide on the important rules of tax.
Claiming tax relief on unpaid loans
If you’re earning enough to be paying tax on your interest, you can claim tax relief on unpaid peer to peer loans. This applies when it’s clear a loan isn’t going to be repaid in full (not when a repayment is simply late).
For the tax relief, you can set the loss against other interest you’ve earned from peer to peer loans before your total income is taxed.
You can find more info on this here.
Alternatives to peer to peer loans
For lower-risk ways to get by at university, we recommend trying these alternative funding sources before taking out a P2P loan or investing in one:
- Student Loan – While Maintenance Loans are by no means perfect (especially as they’re calculated based on household income), they have very reasonable repayment terms and we would always suggest taking out a government loan before borrowing money from elsewhere.
- Part-time job – If you have time around your studies, a part-time job is a great way to earn money at university (and it has the added bonus of boosting your CV!).
- Scholarships, grants and bursaries – You could be eligible for a scholarship, grant or bursary which is effectively free money as you wouldn’t need to pay it back.
- Family – While not everyone’s family can or will lend them money, it’s worth at least asking if yours will, if you need the money. This would involve paying no or minimal interest and would (hopefully!) have flexible repayment terms.
- Savings account – Although savings accounts generally have much lower interest rates than P2P loans, they involve much less risk.
- 0% interest overdraft – One major perk of student bank accounts is getting an overdraft with 0% interest. It can really help you get by between Student Loan instalments without having to worry about interest and you’ll likely not need to pay it all off until the year after you graduate.
- Hardship funds – If you find yourself struggling for money as a student, find out if you could receive a hardship fund from your university. The uni will have some money set aside to help students in financial difficulty, and it could help you avoid the risks associated with taking out a P2P loan.
Investing in peer to peer loans is one way to earn a passive income, but we happen to know of some lower-risk ways to get free money…