Like in the cryptocurrency space where peer-to-peer transactions dominate, Peer-to-peer (P2P) loans are one of the latest forms of investment in the UK. This type of digital investment involves firms linking borrowers or businesses with lenders, otherwise called investors, completely bypassing conventional financial institutions.
Peer-to-peer lending platforms like Zopa, Ratesetter, and Funding Circle can help savers make more with between 3% and 7% in returns annually, a far higher return compared to the traditional banking institutions.
Investors wanting more gains in return are attracted to peer-to-peer loans due to the attractive returns on offer. Here’s all you should know about this upcoming industry.
How It Works
Over ten years now, peer-to-peer platforms bring together potential borrowers and lenders in order to avoid the traditional banks. There are some differences between how banks and peer to peer personal loans UK operates.
The peer to peer company now becomes the middleman instead of the bank. The lender gets a higher interest rate on his investment while also, the borrower enjoys a lower interest rate for repayment compared to the banks when borrowing. It is a win-win situation for both parties in this case, one that is yet to be matched by the banks. The bureaucratic bottlenecks during the borrowing process are drastically reduced and the borrower can quickly get the loan in the shortest possible time.
The principle is that everyone earns a better rate when the middleman which is the bank is taking out of the way. The borrower gets a better deal, and so does the lender.
Each Operates Differently
P2P platforms work in various ways:
Some demand that you spread your money through multiple loans, others permit you to choose precisely which businesses to lend your money to. Zopa, for instance, provides two forms of account: the Zopa Core, which seeks to return 4 percent per year, and the Zopa Plus, which aims at a 4.6 percent annual return. The zopa Plus is considered the riskier investment type. Zopa will allocate your money over a variety of appropriate loans after you pick an account. It goes to say that you won’t have a say in the loan chosen for you in this case.
Instead, you can choose which companies to lend your money to, with interest rates varying from 5.95 percent to 14.25 percent per year. You should do some research to know how each works so you choose the best fit for your investment.
The Innovative Finance ISA (IF ISA) is an investment account that is wrapped in a tax-free ISA. The account enables investors on the P2P platforms to get tax-free interest. The UK government launched the IF ISA in April 2016. It gives peer to peer lenders the privilege to enjoy a tax-free ISA much like the traditional Stocks & Shares ISA and the Cash ISA.
The ISA allows savers to use some of their yearly ISA (£20,000) investment allowance to receive a tax-free interest or capital gains on monies lent via FCA-controlled P2P lending sites and other similar investment platforms.
Nearly 85 companies are currently licensed to provide IF ISAs including Zopa, RateSetter, Funding Circle and Lending Works.
As good and effective as the peer to peer personal loans UK, it is not a totally risk-free system.
Remember the first investment rule relating to P2P: higher returns means higher risks. This isn’t the same as investing the cash in a bank’s savings account.
Investor’s Funds not Covered by Insurance
The risk of a particular borrower defaulting on the terms of their repayments is one major concern. For lenders, compared to banks, their cash is not covered by any insurance on P2P lending platforms. The Government-sponsored Financial Services Compensation Scheme (FSCS), which covers bank savers up to £ 75,000, does not cover the cash borrowed through a peer to peer portal. This means you might lose all your money if the system goes bust or a huge amount is given out to a borrower who defaults. Investors have to be on the lookout for their investments all the time to be current with happenings in the P2P Company and cases of default that may impact on the system.
Though it is believed some peer to peer personal loans UK companies keep some amounts as savings to cushion the effect of a situation that results when a borrower defaults, it is however observed that this amount may not cover up to meet all investors’ funds when the default is huge. It’s even worse that most big peer to peer personal loans UK companies don’t have this reserve.
Difficult to Get Back your Money Promptly
Another downside to this mode of investment is that it can be hard to access your money after you have subscribed to the system, based on the length of your loan. Selling the loan to someone else is often the best way out to quickly get your money back if you eventually find someone who is interested in the investment. Many sites allow you to do this through a secondary market, but it could entail charges.
You can reasonably conclude that choosing a peer to peer personal loans UK site that pays the highest interest rates lets you undertake the most risk. That’s not necessarily true. The reputation of the platforms should be considered instead. You should carry out due diligence before parting with your money to invest in a peer-to-peer company. Platforms measure risk differently. So, when a P2P investor provides a lower interest rate, it does not mean you’re taking less risk in some ways.
For over 10 years now, the peer to peer personal loans UK has gone up in performance, a time of relative stability over financial markets. The industry has yet to encounter a recession in which their loans are defaulted by a large number of borrowers. A financial crash could be one other issue that may lead you to sell your loans on the secondary market. Still, it has been a success all through the years. Therefore, investment using this mode is a worthwhile venture.