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What is Peer-to-Peer Lending?

A Peer-to-Peer (P2P) company matches lenders and borrowers. Simply put, the P2P company will take investments from individuals on the offer of a good interest rate and lend that money to those requiring a loan at a higher interest rate. For a lender the rate offered is better than banks’ savings rates and for a borrower it is better than a bank loan.

It is generally accepted that P2P lending started commercially in 2005 to help small companies obtain funding and has grown rapidly since then. Two of the UK’s largest P2P lender, Funding Circle and Ratesetter, now has loans outstanding of more than £1bn. The financial markets have accepted this form of lending and banks are starting to make their own offerings.

The market for P2P lending has also expanded from those providing loans to businesses and now there are P2P companies specialising in mortgages, personal loans and bridging finance.

P2P companies are not currently regulated by the Financial Conduct Authority, though there are strong calls for the industry to become regulated. More importantly for investors, P2P companies do not fall within the scope of the Financial Services Protection scheme, so that if a company with whom you have invested fails, any money invested through them could be lost.


About The Peer to Peer Loan

The P2P companies have made applying for a loan more straight forward than the traditional banks.

For corporate loans a business plan is usually required including financial and cash flow projections. The P2P company will wish to ensure that the plan will result in repayments being affordable to avoid defaults.

The rate offered to a borrower usually depends on the perceived risk of the investment. You will be obliged to pay that loan and usually the loan has a personal guarantee. This means that even if your company fails, you are still liable personally for that loan, which is similar to other loans such as the government’s start-up loan scheme and bank loans.

Where the loan is personal or for a mortgage the individual’s personal circumstances are brought under scrutiny.

The advantage of P2P loans is that they are usually cheaper than bank loans. This is achieved by reducing the overheads in running the loan.

If you run into difficulties repaying the loan, the P2P company usually helps you resolve the issue as will a bank. It is always important to keep the lender aware of difficulties as they do not want you to default because it will cost them money as well as creating difficulties for you.


About The Peer-to Peer Investment

Investing is usually very simple. Decide how much you want to invest and for how long you are happy for that money to be invested. Then you can survey the market to see the offerings from the P2P companies.

The interest rates and the way interest is paid vary:

  • Some pay the interest at the end of the term, annually or monthly
  • Some companies offer a degree of protection against investment failures
  • Some charge fees
  • Some allow you to sell your investments to others who are already invested


Deciding what to invest in

A further decision is to decide which market you want your money invested in. Some P2P companies specialise in the corporate sector, giving you freedom to choose the companies in which to invest, whilst others operate in the mortgage or personal loan sector, where the funds are pooled before making loans. It is your decision based on all these factors.

Once invested the P2P company will either invest the funds into opportunities that they select, or leave the investment for you to select. However, this is usually restricted to the corporate loan market. In such cases the P2P company will usually screen the company requesting a loan and set a risk factor against it, offering the investor a higher rate of return for more risky investments. It is then your choice as to whether you invest in that company.

After a period, should you decide to withdraw your funds, there is often an internal market for you to sell to other investors. However, there is usually a fee attached to this and you may not achieve the full value.


The Reasons to Invest, or Not

Investing in anything that offers a higher rate of return than the bank includes an element of risk. This is also true of P2P lending. Currently (January 2017) rates of interest are being offered ranging from 3% to 7%. This is substantially higher than the banks but it does carry some risk. It has been said that with P2P lending, only invest what you can afford to lose. However, the P2P companies would not agree with this and would cite that they now have substantial funds ring-fenced so that if a company cannot repay their loan, the P2P company would reimburse the investor.

With P2P lending being included within ISAs shortly the interest becomes tax-free, which adds to the attraction.


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