Peer-to-peer lending offers an innovative way to invest and earn a return on your money, which is often far greater than using a typical savings account or ISA from your high street bank.
Peer to peer lending allows you to invest in the loans of other people or businesses and earn an annual return of up to 15% per annum, compared to the average ISA from your bank which is around 2% to 3% per annum.
Figures show that around £9 billion has been invested into peer to peer lending by Britons in the last year – and the rate is growing.
How does peer-to-peer lending work?
Peer-to-peer lending involves using a portal to match investors with those individuals or businesses looking to borrow money. The whole process is completely anonymous and your investment is often diversified across multiple parties to minimise risk.
There are a handful of peer-to-peer lenders in the UK, including Zopa, Ratesetter and Fund Ourselves who simply take a commission in between the loans and savings, known as arbitrage.
The potential return on investment ranges between 3% to 15% based on how much risk you want to take on as an investor. Those borrowers with good credit ratings will be able to offer lower returns starting from 3% and those with bad credit ratings will require investors taking on more risk and therefore earning a greater reward of up to 15%.
However, the rates of return are based on the loans being paid on time, hence your final return may vary. Our list below offers a number of ways to maximise your return from peer-to-peer lending.
Compare the rates
Some peer-to-peer lenders offer different returns on investment depending on the products that you are investing into.
For instance, investing in secured loans or businesses with collateral may offer a higher return than investing in unsecured loans.
Equally, some peer-to-peer companies may offer better rates as a way to incentivise new customers – so comparing rates across the different lenders is a good starting point.
Use the innovative finance ISA
Check if your desired lender is eligible for the innovative finance ISA which offers any savings you make up to £20,000 tax-free.
You can only use this on one financial product, including any bank ISAs that you may have, so make sure that you fully understand the terms and conditions before using this benefit.
You may need to keep your money in for the full term
To earn the full return rate offered, you may need to keep your money locked in for the full duration of the loan terms – and this is usually a minimum of 12 months.
A lot of peer-to-peer lenders will offer things like easy withdrawal, but always check the terms and conditions because this could come with penalties or a reduced overall return.
Understand the role of compensation schemes
Peer-to-peer loans are not covered by the financial services compensation scheme, which covers you or your business for any losses on credit cards due to products not delivered, faulty services or fraud.
This means that if your investment is lost or does not materialise for some reason, you are not covered by any government schemes.
There is always the risk that customers will default on loans or the businesses that you are investing in will go out of business.
This is usually the role of the peer-to-peer platform to have a scheme in place to chase up bad debts.
Understanding from day one that your capital is at risk is vital and also be aware that your expected return may not be returned in full or may be delayed.
The risk of your lending going bust
There have been a number of high profile lenders in the industry that have gone busy including Lendy and FundingSecure – and they have investors who are waiting for millions of pounds to be paid out.
This is where diversifying any investments you plan to make across multiple peer-to-peer platforms could be useful – and avoid putting all your eggs in one basket.
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