What is peer-to-peer (P2P) lending?
With many investment options to choose from, it can sometimes be difficult to decide which is right for you. If you want to diversify your investment portfolio, peer-to-peer lending is a relatively new strategy you might wish to consider. On this page, you’ll learn more about peer-to-peer lending, the opportunities it can provide, and the risks involved. We also consider the alternatives to peer-to-peer lending, such as opening a high-interest savings account.
- P2P lending meaning: Peer-to-peer lending is a type of investment strategy wherein individual investors loan money to borrowers such as small companies through an online platform
- Higher interest: To reflect the increased risk to investors, the interest rates offered through peer-to-peer lending are usually higher than those available with a traditional savings account
- Tax implications: Generally speaking, the money you earn from peer-to-peer investing is considered income, so it’s taxed based on the income tax band you’re in.
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Peer-to-peer lending explained
Peer-to-peer (P2P) lending allows individuals to accept loans directly from other individuals, as opposed to those offered by banks or building societies. As a lender, you’ll receive interest and get your money back when the borrower repays the loan. Lenders, such as individual investors, and borrowers, such as small companies or other individuals, come together online through online P2P companies and platforms, keeping overheads to a minimum.
How does peer-to-peer lending work?
Investors can search for online P2P lending platforms that will connect them directly with borrowers. Each platform has its own rate and terms that control every transaction between investor and borrower. The rates of interest are usually based on the credit score of the applicant or borrower.
When you open a new account as an investor, you’ll typically have to invest a sum of money that will be given to borrowers in the form of a loan. A loan applicant, or borrower, has a financial profile with an assigned risk category, which determines the interest rate they will have to pay (and that you will receive as the lender).
The applicant can review offers from you and other lenders and accept one or more, depending on how they wish to take their loans. The platform you choose handles the transactions on your behalf.
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What are the risks and opportunities of peer-to-peer lending?
|Peer-to-peer lending automation reduces the hassle of managing your investments manually.||The person or company you lend money to may default on the payment and not be able to pay it back.|
|You can start peer-to-peer lending with a relatively low amount, and still get a good rate of interest on your investment.||If a borrower repays your loan early, your profit might be lower than expected.|
|You can customise your loans by choosing the amount you want to loan, the borrower’s risk level, and other terms.||Depending on the P2P provider, the Financial Services Compensation Scheme (FSCS)* may not cover your loan.|
|P2P lending can potentially provide higher interest rates than traditional banks can offer (although the risk is greater).||You may not easily find suitable borrowers for you. The more you invest in a P2P lending platform, the longer it may take to find a borrower.|
|You can diversify your investment portfolio by spreading your money across multiple loans.||Some people still consider P2P lending to be in its infancy, meaning there is a lack of stability and regulation.|
Peer-to-peer lending and tax
The money you earn through P2P lending is classified as income, meaning you’ll pay tax above the personal savings allowance (PSA) according to your income tax band. The personal savings allowance for basic rate taxpayers is £1,000, and £500 for higher rate taxpayers., so you’ll need to pay tax on any interest you earn above these amounts. Additional rate (45%) taxpayers don’t receive a PSA, meaning all of the interest they receive is subject to tax.
It’s worth noting that some P2P lenders will allow you to invest up to £20,000 through an Innovative Finance ISA. In this case, any interest you earn on that portion of your investment will be exempt from tax.
Is peer-to-peer lending right for me?
P2P lending presents a new opportunity for individual investors to earn money through lending. It can be a good option for those who wish to invest small amounts rather than lump sums, in a bid to earn high interest rates. However, if you don’t have any savings behind you or you’re in debt, peer-to-peer lending is unlikely to be the right option for you
It’s always best to consider how much risk you’re willing to take before you jump into P2P lending. Sometimes, investing in P2P depends on your luck in finding reliable borrowers who can pay back their loans.
Peer-to-peer lending: key points to consider
While peer-to-peer lending may seem like an attractive investment option, it won’t be suitable for everyone and there are some important points to consider before you commit.
- P2P lending is not the same as a savings account – although peer-to-peer lending may appear to be similar to a savings account (with the added benefit of higher interest rates), the two are very different. P2P lending is a form of investing and, unlike savings accounts, isn’t covered by the FSCS.
- Never invest more than you can afford to lose – as with other types of investing, there’s a risk that you could lose some or all of your original investment. You should therefore only invest as much as you can afford to lose.
- Advertised interest rates aren’t guaranteed – one of the biggest draws of peer-to-peer lending is the high interest rates on offer. Bear in mind, however, that the advertised rate will usually be quoted as a “projected”, “target” or “expected” rate of return. There’s no guarantee you’ll receive this rate; you might receive less or even no interest at all.
- It can be difficult to access your money – you’ll normally need to sell your loan to another investor if you want to access your cash. While this may not be an issue when the economy is booming, you might find it more difficult to find a suitable buyer during a downturn.
- New P2P investors can’t lend more than 10% of their ‘investable assets’ – following changes introduced by the Financial Conduct Authority in 2019, new peer-to-peer investors can’t put more than 10% of their ‘investable assets’ into a P2P platform. You may be able to invest more than this amount if you’ve sought professional financial advice or you’re an experienced investor.
Alternatives to peer-to-peer lending
If you decide peer-to-peer lending isn’t the right path for you, there are alternative options you can consider. If you’re happy with taking on some risk, you might want to think about investing in the stock market. Again, returns aren’t guaranteed but it can be financially rewarding if you’re prepared to take a long-term approach. Find out everything you need to know about investing in the stock market with our handy investment guides.
Alternatively, if you’ve decided that investing poses more risk than you’re comfortable with, you could put your money into savings accounts which offer competitive rates of interest, such as fixed rate bonds. These types of accounts allow you to lock your money away for a set time at a competitive interest rate that won’t change until the end of your fixed term. Plus, unlike peer-to-peer lending, your money is protected under the FSCS (up to £85,000 per individual, per banking group).
You can choose from a range of competitive fixed rate bonds in the Raisin UK marketplace. To get started, simply register for a free Raisin UK account today.
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