Can peer-to-peer lenders really give you 10% on your savings?

The government announced in this year’s budget that cash in peer-to-peer lenders can be held in Isas from April 2015. A consultation on how this will work is underway, with proposals including a third Isa, or allowing these loans in existing stocks and shares Isas.

While lenders such as Zopa, RateSetter and Funding Circle are far less familiar names than high street banks, this sector has been around for about a decade. The sites match people with money to save, to individuals or small businesses who need to borrow. By cutting out the banking middleman, savers benefit from higher rates without a mark-up on the deal.

There are now more than 100,000 people investing, according to the Peer2Peer Finance Association.

  
The players

Best-known are Zopa and RateSetter. “Between them they account for around 47% of the market – both accept funds from consumers and lend mainly to personal customers,” says Andrew Hagger, personal finance expert at MoneyComms.co.uk.

However, plenty more have joined the fray. They all operate in different ways, and some are more niche than others, but all lend money to individuals, businesses or property developers. These include Funding Circle, ThinCats, Wellesley & Co, Assetz Capital, Lendinvest, Landbay and FundingKnight.

What about returns?

Zopa currently advertises a rate of 4% for up to three years and 5.2% for five years, after its 1% fee is deducted. RateSetter last week quoted returns of 2.5% over one month, 3.8% for one year, 4.7% for three years and 5.9% for five years.

Giles Andrews, CEO of Zopa.
Giles Andrews, CEO of Zopa. Photograph: Steve Franck
But don’t get too carried away with the headline rate. Amy Ellis from Moneysavingexpert.com, says: “The advertised rates on the biggest peer-to-peer sites are generally after fees and bad debts, but before tax – so the actual return that you’ll get will be lower than advertised in big numbers when you land on the website.” The interest you earn is subject to income tax in exactly the same way as normal savings accounts. So if you’re a basic rate taxpayer, you’ll have 20% shaved off, 40% at the higher rate and 45% at top rate.

It is possible to get higher rates depending on how much interest borrowers are prepared to pay on the loan. Typically, the top rates are reserved for riskier borrowers. Funding Circle, which quotes an average 7.1%, offers a risk rating of A, B, C or D for businesses seeking loans through its site. The lower the rating the higher the risk, but the greater potential return.

Some of the lesser-known sites quote particularly eye-catching returns. FundingKnight claims its lenders receive an average 10.7%, while ThinCats quotes 9%. Hagger explains that businesses that borrow via peer-to-peer sites will pay higher rates. “But sometimes they are stated without an allowance for predicted bad debt – so check the detail,” he adds.

Who invests?

The Marshall family, David, 58, Pauline, 50, and their son Zach, 19, have, between them, put a chunky £60,000 in Zopa. “I heard about peer-to-peer websites in August last year from a friend. I searched online as I was fed up earning next to nothing on my savings, and found Zopa. I liked that it wasn’t a faceless bank, and that you can see where your cash is going,” says David.

He opened an account with £2,000, and added to this as he became more confident. “I was happy with the safeguards, and my wife and son soon followed suit.”

He says that on average they each receive around 5% after fees over five-years, with their money spread across thousands of borrowers. Interest is paid monthly, and this is reinvested.

David and Pauline see the money as part of their retirement funds, while for Zach it’s more about developing a disciplined approach to saving.

“My son has around £14,500 invested, and from his perspective it’s great as he can see how his money is growing and helping others – it encourages him to take an active interest in his savings,” says David.

What about the risks?

Since April peer-to-peer lenders have been regulated by the Financial Conduct Authority, which means greater protection. This includes a requirement that steps would be taken to make sure repayments on existing loans would continue to be collected if a site went bust.

Yet, crucially, they aren’t covered by the Financial Services Compensation Scheme, which guarantees savings up to £85,000 per institution, if that institution were to collapse.

Many sites are members of the Peer2Peer Finance Association, a self-regulatory body that has a code of practice. A spokesman says lenders must have been operating for six months to become members.

The clear risk is that a borrower fails to repay your loan. However, several sites have a scheme to cover losses. Zopa has a “Safeguard” fund while RateSetter has a “Provision Fund”.

“Both Zopa and RateSetter take a fee from borrowers and use some of this to build a safety net so that if borrowers are late paying, or don’t repay, this can be absorbed,” says Hagger.

RateSetter’s fund to guard against bad debt holds £8.7m. It boldly states that not one of its 16,100 savers has lost a penny since it started in 2010.

You can invest £25 per business with Funding Circle, and it advises splitting your investment among multiple businesses to reduce the risks.

How do I apply?

Simply go to one of the peer-to-peer websites, choose how much to lock away, for how long, and get a fixed rate.

Minimum amounts typically start around £10, enabling you to dip your toe in the water, and periods on offer range from a month to five years. Your money is lent in small chunks to a number of borrowers, and you receive repayments each month, made up of interest and the money you lent. You can choose to reinvest or withdraw.

When you’ve registered and handed over your cash, you can see details of all the individuals or businesses you have lent to. Be prepared to tie-up your money for the agreed term. You may be subject to a fee or lower rate if you withdraw cash early.

Spreading your money between several of these websites is one option. As Hagger warns: “There are a number of new providers entering this market, so beware of being lured in by some of the high rates quoted without doing a bit of groundwork.”

WHERE ELSE?

If you feel more comfortable sticking to bank and building societies, it’s not all bad news. You can get a decent rate in some current accounts, with a number paying up to 5% on balances of around £2,500. The seven-day switching scheme makes it simple to move, and many offer cash incentives.

TSB and Nationwide building society offer current accounts paying 5%; Lloyds Bank pays 4%; Santander’s 123 pays 3% on balances from £3,000 to £20,000 plus cashback on household bills, which is likely to more than wipe out the £2-a-month fee.

Meanwhile, cash Isa rates have been tumbling since the introduction of the Nisa in July, in which savers can put up to £15,000 a year. The typical rate on an easy access Isa has hit 1.17% after falling for five months in a row, according to Moneyfacts.co.uk.

The best fixed-rate cash Isa from Coventry building society pays 2.6% to 30 November 2018, while the top variable rate, easy-access account from BM Savings pays 1.6%.

Turning to standard savings accounts, the top one-year fixed-rate pays just 1.85% from BM Savings, part of Halifax.

Over three years you can earn 2.5% from United Bank and, over five years, Tesco Bank pays 3.1%. Among the best- buy easy-access accounts, Virgin Money pays 1.3% on its Easy Access Saver with no bonus or withdrawal restrictions.

- October 26, 2014