Moneywise looks at how to take advantage of the boom in peer-to-peer lending while avoiding the risks that investors can fall prey to.
If something seems too good to be true, it probably is. Yet in a world of stagnant interest rates, some peer-to-peer (P2P) platforms are enticing savers by offering returns of more than 10% a year..
The P2P market has grown rapidly in the past few years as more people have looked to make their money work harder. But there are some crucial differences between this investment and traditional savings accounts.
Understanding the basics
At its heart, peer-to-peer is a simple concept. It allows consumers to lend to others using a platform or provider as a middleman.
The appeal is that investors typically enjoy better returns than those offered by savings accounts while borrowers get lower loan rates than they’d usually find on the high street. Some of the bigger platforms include Funding Circle, Lending Works, RateSetter, and Zopa. While they are all peer-topeer platforms, each has its own way of investing your cash.
Lending Works and Zopa offer loans solely to consumers, while Funding Circle deals only with business borrowers. RateSetter offers a mixture of the two and other platforms can be more specialised, such as Lendy, which offers loans exclusively to property investors. Each platform allows users to customise the level of risk they’re taking on to some degree.
With Zopa, investors can choose a high- or low-risk product – either Zopa Core, which targets returns of 3.7% a year, or the riskier Zopa Plus, which has a projected 4.5% annual return. Zopa then chooses which individual borrowers get loans on your behalf.
For a more hands-on approach, LendingCrowd allows you to choose the exact loans you want to invest in. You can also usually sell your loans to others – this is known as the secondary P2P market.
As well as growing in popularity, the reputation of P2P was boosted by the launch of the Innovative Finance Isa (IF Isa) in April 2016. This gives consumers a means to invest tax-free in P2P for the first time. There are now more than 50 providers offering IF Isas, although some major players, such as Funding Circle and RateSetter, have yet to launch.
But take-up of the IF Isa has been underwhelming. Just 2,000 accounts were opened in the 2016/17 tax year according to HM Revenue and Customs (HMRC), although the average investment was £8,500 – similar to the typical amount held in a Stocks and Shares Isa.
Danny Cox, chartered financial planner at Hargreaves Lansdown, says: “P2P has been growing fast, but is still a long way from mainstream. Total loans outstanding are less than £4 billion, so despite the impressive growth it is still tiny compared to cash savings and stock market investing.”
Taking on risk
Before opening a peer-to-peer account, it is crucial to weigh up the risks. The most important fact to consider is that P2P is an investment, rather than a cash savings account.
Despite being featured alongside savings products in best buy tables by price comparison websites GoCompare and Love Money, and being billed as a type of savings account by Money.co.uk and MoneySupermarket, your cash is at risk and you may get back less than you put in. Money lent through a P2P platform is not covered by the Financial Services Compensation Scheme (FSCS), which protects deposits held in savings accounts up to £85,000 per person per institution.
While investors usually do not pay any upfront fees, there may be charges when you come to sell your loan.
In addition, each provider has its own way of assessing the risk of the people or businesses it lends to, and this is something investors need to consider carefully. You should not assume lower targeted returns mean one provider is safer than another. Risk cannot be judged based on these expected returns alone.
Crucially, the peer-to-peer market has yet to go through a financial downturn, something which is likely to cause more borrowers to default on their loans. A financial crash may also increase the amount of time it takes to sell your loans on the secondary market if you don’t want to stick with them until the end of the loan term.
RateSetter estimates that bad debts would need to hit four times their current levels before investors started to lose their initial investment – but this hypothesis has yet to be tested in the real world.
Mr Cox says: “P2P has not yet been through a full normal market cycle, so we have not experienced the impact of high interest rates, high inflation and high default levels on the market.
“The interest cost of a P2P loan is actually quite small. It is the repayment of the capital that is the problem. This means the business lending P2P market will be sorely tested when businesses start to flounder or fail in a recession, and on the personal lending side when unemployment rises.”
Some platforms have safeguard or provision funds, which are designed to pay investors if loans perform below expectations. But a common misconception is that these funds have enough cash to fully reimburse all investors. In a major financial recession, it is likely that the losses would be greater than a provider’s total provision fund.
One major platform, Zopa, has taken the decision to wind down its safeguard fund. All existing loans covered by the fund will be protected until maturity, but no new investments made since June 2017 have received safeguard protection.
Zopa told Moneywise that investors prefer the “simplicity” of its non-safeguarded products. Neil Faulkner, managing director of P2P comparison service 4thWay, says the platform is looking to boost investor returns by winding down its provision fund.
“Zopa no longer needs the complexity of having a provision fund and so it is reverting to a simpler model that is easier to operate and to explain to investors,” he says.
“Investors have focused heavily on P2P lending platforms with provision funds and this has probably helped to push interest rates downwards – in some cases too far.”
Managing your investment
As with all investments, there are a few steps you can take to minimise the risks:
- Invest your cash in multiple peer-to-peer platforms or providers. This means if one platform or provider goes bust you won’t lose all your cash. Similarly, if fraudulent activity was taking place on one platform, you would not be overly exposed.
- Make sure you pick a varied portfolio and are not exposed to one sector, such as having all funds in property loans.
- Always keep a pot of cash aside for a rainy day, especially as you may not be able to sell your loans quickly in future.
The lack of liquidity offered by peer-to-peer has been criticised by one investor, Jonathan Yonge of Winchester, Hampshire.
The 64-year-old, who manages his own portfolio of assets for a living, has encountered difficulties when trying to sell loans using Zopa. He currently has around £220,000 invested in the Zopa Access product and a further £100,000 in Zopa Plus. Zopa Access has now been closed to new investors and Jonathan has been unable to sell most of his loans.
“A couple of months ago, Zopa said it was going to retire some products and replace them with a different product [Zopa Core].
“As the returns have fallen, I tried to sell my loans but have experienced major delays. Some days I don’t sell a single loan. The maturity of these loans goes up to five years and liquidity is very limited.”
Jonathan says he entered the peer-to-peer market because he expected greater liquidity than other asset classes, but this has not been the case.
“As an investor, I’m reliant on the person who sold me the asset for the resale. The market is controlled by Zopa, which can change it without notice. There needs to be more competition and the ability for the loans to be sold more widely. This is a major weakness of peer-to-peer products.
“I made a mistake putting so much money in. I’ll keep trying to sell my loans but it will be around 18 months at this current rate of sale.”
Zopa confirmed to Moneywise that customers had been experiencing delays when trying to sell their loans.
“Recently, some of our automated processes have been running slower than normal, resulting in it taking longer for our investors – including Mr Yonge – to sell their loans and access their money early,” a spokesperson says.
“There is still plenty of interest from our investors to buy these loans and there are no liquidity issues. We’d like to apologise to our customers who have been affected by the slower loan sale times – including Mr Yonge.”
Zopa has also encountered difficulties in finding enough suitable borrowers to match with investors. Its platform has been closed to new investors for much of 2017, although existing customers have been able to invest further cash without any restrictions. It has a waiting list of around 15,000 potential investors and says it hopes to re-open by the end of the year.
These are not the only issues facing peer-to-peer providers. In July, RateSetter admitted that an £8.5 million loan was in financial difficulty.
The loan, made through a wholesale intermediary, was underperforming and RateSetter itself was forced to guarantee the loan and take control of the failing firm, Adpod – an advertising company.
RateSetter says it made an error approving this loan and that its parent company stepped in to cover any losses, rather than it having to use its provision fund.
It has increased its lending checks and will no longer agree to any single business loan worth more than £750,000. RateSetter also no longer lends using wholesale intermediary firms, a practice which the Financial Conduct Authority has condemned.
Elsewhere, property platform Wellesley & Co withdrew its P2P product from sale this summer amid a financial restructuring at the fi rm. This followed several major loans worth a combined £10.1 million entering financial trouble.
Neil Faulkner of 4thWay is critical of the way Wellesley operates, saying it does not provide as much data to customers as other providers regarding its performance, bad debts and security.
“There is a lot about Wellesley that concerns me, including director pay and the ambiguity of information provided to individuals doing P2P lending through Wellesley,” he says.
Mr Faulkner also points to its low margins and high leverage as causes for concern.
In response, Wellesley says: “We believe the standard of data is in line with other major peer-to-peer lending firms. We consider the quality and level of disclosure in our accounts to be among the highest in the industry.”
Return on investment
Despite these troubles, investors are still flocking to peer to peer. Data from the Peer-to-Peer Finance Association trade body – which represents around 80% of the market by volume – shows there were 185,652 consumers actively lending through its member firms in the second quarter of 2017.
Returns are still much higher than those offered by savings accounts, although they have fallen in the past couple of years.
Moneyfacts says the average annual return on a five-year, fixedrate bond was 1.93% in September 2017 while the average Isa paid 1.71%. By comparison, RateSetter’s market for five-year loans currently pays 5.9% and Lending Works targets a 5% annual return over this time.
Two years ago, Zopa targeted 5%, with safeguard protection, but now targets 4.5% even though it lends to riskier borrowers. If you exclude the riskier borrowers, the targeted return is now 3.7%. Moneywise reader Adrian Jacobs (pictured below), 57, lives in Dorset and has been pleased with the returns he has received. “I have been investing in four different platforms – Bondmason, Funding Secure, Lendy, and Zopa – over the past three years,” he explains.
“Lendy offers some very large loans, with very good interest for the investor – 12% a year – but requires constant daily management on my part,” he adds.
“Others, such as Zopa, requires much less involvement from the investor. It’s almost an ‘invest and forget’ platform. But the interest rates are much lower accordingly.”
However, the product marketing engineer has been disappointed with the returns achieved in 2017 and now wants to sell his holdings and return to traditional forms of investment.
He says: “In the past few months, there has been a marked decline in the interest rates on offer and the number of new opportunities to invest in, and generally increasing risk levels. It’s becoming quite difficult to reinvest in worthwhile loans at reasonable risk levels.”
Mr Faulkner adds: “I believe there are two reasons for these falls across the market. The fi rst is P2P lending platforms have been competing with banks and other lenders to win borrowers, which has driven rates down.
“The second, and bigger, reason is that when the platforms are small and new they can be ultra-selective of borrowers. Therefore, from the pool of high-quality borrowers they can pick and choose the ones that agree to pay higher interest rates without shopping around. As platforms become more established and lenders start piling in, this drives interest rates down.”
‘I would only use money I could afford to lose’
Civil engineer Tony Farrar (pictured above) lives in Colchester, Essex. The 71-year-old started investing with small amounts and has gradually built his portfolio. He has also increased the level of risk he is taking on.
“I started by investing in Funding Circle with small amounts - £20 here, £50 there,” he explains. “Initially, I split my loans between regular loans, those against a fi xed asset and those classifi ed as high risk. The high-risk loans gave considerably the best return. If you’re going to put money into P2P, where the whole idea is high risk, I believe you might as well take the highest risk possible.
Mr Farrar now prefers to invest though specialist platforms to get these higher returns. “I use FundingSecure and lend to people who are borrowing against a fi xed asset, such as a house, and I usually get a rate of around 13% a year,” he says. “I don’t see the point in some other providers where you get a return of 3% to 4% a year and there is still a lot of risk.
“I have around £3,000 in there and I’m more than happy with that, but I would only use money I could afford to lose,” he adds.
‘I feel very comfortable with the level of risk’
Allison Small (pictured above), 57, from Essex is a reservations manager for a travel company and turned to P2P to get a better return on her savings.
“I started investing in peer to peer in 2013. I had a small pot of money – around £5,000 – which was not enough for property investment but I wanted a better return than I’d get from a savings account,” she says.
“Returns have been very good and I have reinvested them and added more to the pot when I’ve been able to. I now have just over £30,000 in savings, of which I’ve invested around £25,000 and the rest have been my earnings on the investment.”
Alison adds: “There are fees to be paid and some loans have defaulted, but I am looking at an annual return of around 7.3% after that.
“There are always going to be bad debts, so you have to be prepared for that. But even if bad debts increased I still think I’d be earning more than going somewhere on the high street. I feel very comfortable with the level of risk I’m taking.”
‘It feels more like an old building society model’
Hazel Muir (pictured right), 50, from Tunbridge Wells, Kent has investments with both RateSetter and Zopa. She was attracted to peer to peer after losing faith in high street banks.
“The main appeal to me was that after the financial crisis in 2008, I liked the model of peer to peer as it is borrowing and lending on a fairer basis,” she says. “It feels more like an old building society model in some ways. The rates seem fair to both borrowers and lenders.”
The science journalist started investing for the first time in 2012 and has since increased her investment. She now has around a fifth of her savings in peer to peer, with the remainder in cash savings accounts and Isas.
“Interest rates are really good. Last month I was getting around 5.4% from RateSetter. It is a risk but I am not putting all of my eggs in one basket – the rest of my money is in other places.”
Moneywise verdict
Peer-to-peer investing has been a boon for people looking to make their cash work harder in recent years. Returns have been very impressive, although they have fallen recently as the market has matured.
If you’re looking to invest, make sure you get the basics right. Diversify your portfolio, always keep a pot of readily accessible cash, and beware that your investment could lose value.
Choosing a peer-to-peer platform can be a difficult task. For beginners, Moneywise recommends using mainstream platforms and, once you’re more experienced, you can move on to more specialised providers if you wish.
Our top picks are Funding Circle, Lending Works, RateSetter and Zopa. All scored highly at the Moneywise Customer Service Awards 2017, with Zopa taking the award for Most Trusted P2P Provider and Lending Works being named the Most Trusted P2P Platform for Savers.
For more experienced investors, Mr Faulkner points to Funding Secure, Growth Street, and Proplend as three platforms currently offering good value to investors.
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