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Peer-to-peer lending: do the risks outweigh the rewards?

It sounds risky: lend some of your hard-earned cash to a stranger, charge them an interest rate that suits you both and then trust them to pay you back. Yet it appears there are plenty of people willing to do just that.

Peer-to-peer lending has really taken off in the UK. Three of the biggest peer-to-peer (also known as social lending) websites: Funding Circle, RateSetter and Zopa, have lent over £250 million of investors’ money to borrowers so far.

This comes after the government announced at the end of May that it’s planning to pump up to £100 million into alternative lending.

These websites allow people and businesses to lend to and borrow from one another without needing to go to a bank. By cutting out the middle-man (the banks), borrowers can find better loan rates while investors get higher returns than most saving accounts can provide.

Are savings rates good enough?

A glance at the traditional savings market right now shows that people willing to put £5,000 into an easy-access savings account can expect to get an average interest rate of 1%, while you’ll get an average of 1.85% for an easy-access Isa. The best instant access account you can pay into at present is with Santander at a rate of just 3.2%

On the other hand, on peer-to-peer websites, the average rate of return ranges between 5.6% on Zopa to 5.95% on Ratesetter after fees and bad debt are taken into account, while Funding Circle’s average is 5.7%.

The higher interest rates that come with peer-to-peer lending should also be considered seriously alongside the risks. Many sites have ways of containing the impact on lenders if borrowers default, such as spreading each lender’s money between numerous borrowers.

But at Which?, we’re worried that the number of borrowers defaulting on their loan repayments might rocket as more people struggle with their finances, putting more investors’ returns and capital at risk.

It’s also worth remembering that peer-to-peer sites are not covered by the Financial Services Compensation Scheme, which means your money could be at risk if the lending company goes bust. They are licensed by the Office of Fair Trading for lending activities, but with peer-to-peer lending you don’t have any statutory rights, nor can lenders complain to the Financial Ombudsman Service.

Happy customers of peer-to-peer lending sites

Despite the risks, there are plenty of people pleased with their peer-to-peer lending experiences. Commenter Barryg told us:

‘I have saved with Zopa for around three years and have just two bad debts to date. I have an average interest rate of 6%. Very satisfied with Zopa so far and expect to increase investment.’

Steve started slowly but is upping his game:

‘I have invested a reasonably substantial sum with RateSetter over the last six months. I started slowly but I’ve received all the money I’ve expected and am getting about 4% with monthly access. In the last month I’ve started reinvesting into the longer markets.’

Would you be tempted to try peer-to-peer lending? Do you think it’s a positive concept, or do the risks put you off?

Comments
Profile photo of John Ward
Member

I don’t think the rewards are commensurate with the risks, even at a return of 5.95% nett after fees and bad debts are taken into account. It’s one thing to price in the risk of the borrowers defaulting, but what if the intermediaries crash? Who is regulating them? What are their solvency margins? There might even be a temptation for savers to channel more money through this route than is prudent for their circumstances. It’s only appropriate for the very top slice of one’s savings, i.e. money one can afford to lose completely.

Profile photo of richard
Member

I would only contribute if I had totally surplus money – as I like a gamble – I no longer do because this appalling “government” reduced my savings income by 90% – no “funny” money left

Profile photo of terryindorset
Member

It may sound good at the moment but wait until the crooks move into this sector…goodbye your money.
Do what I do – trust no-one. I don’t even trust my high street bank!