Is Peer to Peer lending an alternative to a cash ISA?
Last month’s article on cash Individual Savings Accounts (ISAs) sparked some interesting emails to arrive in the Savings Guru inbox. Many people hadn’t realised that the same non-ISA savings account often paid a significantly lower interest rate and that the tax benefits to savings in an ISA were not there for so many savers with the advent of the new personal savings allowance.
A number of you had seen the advent of the new Innovative Finance ISA for Peer to Peer lending and wondered how these worked, if they had a separate allowance to cash ISAs and whether they were a better alternative to cash ISAs. So here’s my overview and thoughts on Peer to Peer lending and the new Innovative Finance ISA:
What is Peer to Peer Lending?
Peer to peer (P2P) lenders effectively replace banks as the middleman in financial transactions by matching savers with borrowers. These borrowers can be individuals or companies. Whereas banks operate on what is known as Net Interest Margin (NIM), which is the difference between the interest rate money is paid to savers and the rate paid by borrowers, P2P companies typically charge a fee (which is taken from the return, rather than being paid upfront by savers) for their match making.
Is my money protected?
The big difference between P2P companies and banks is that there is no financial protection for savers with P2P whereas savers with banks are protected by the Financial Services Compensation Scheme (FSCS), within the scheme limits. There is a chance that savers can lose their money.
How risky is P2P?
It is possible that savers could lose all their money but P2P firms do a number of things to limit risk for savers. Money is spread across a number of borrowers to limit the risk of loss e.g. if a saver puts £1,000 in, this may be lent to 50 borrowers who get £20 each. The P2P firms also carry out their own checks on the borrowers and many grade them according to the level of risk. A savers portfolio can therefore have a range of borrowers in with differing interest rates to reflect the risk.
Is P2P unregulated?
No – since 1st April 2014, the industry has been regulated by the Financial Conduct Authority which requires firms to present information clearly to customers, be honest about the risks involved and have contingency plans (in case things go wrong). Firms who don’t follow the rules can be fined or face sanctions from the regulator.
What’s the attraction to save with a P2P instead of a bank?
For savers, the projected interest rates on offer are far higher than those on a savings account. With the best instant savings account paying 1.30% and the top five year rate offering 2.60%, returns of 4 – 6% from the major P2P firms compare favourably and this has made them attractive for many savers, despite the risks.
How does the Innovative Finance ISA work?
It works very similar to a normal ISA. There’s no separate allowance so the £20,000 ISA allowance applies which means that savers can use it all on an IF ISA or put hold sums up to £20,000 across cash, stocks and shares and IF ISAs. Interest on P2P investments is treated the same as bank interest from a tax perspective so anything over the personal savings allowance limits (£1,000 for basic rate taxpayers and £500 for higher rate taxpayers) is liable to tax. With the potential for higher returns, the IF ISA is popular as the personal savings allowance limits can potentially be breached on much smaller sums than a savings account.
How popular is P2P lending?
In January this year, the Peer to Peer Finance Association, a body that represents a number of P2P firms, including some of the largest, announced that lending on its members platforms had exceeded £8bn. While the overall size of the market in the UK is hard to predict exactly, we estimate it is approximately £12 – 15bn. This is dwarfed by the £1.5tr held by banks but P2P continues to grow quickly. Zopa, the oldest P2P lender, was only set up in 2005 so the industry has developed rapidly.
Is there anything else to be aware of?
With a savings account, savers start earning interest on the day they put their money in. With P2P lending, this will be when your funds can be matched to a borrower – this is not always straight away. It may only be a few days but, with larger amounts, it could take a few weeks to drip feed it in.
Similarly, although some P2P firms offer accounts where you can access your money relatively quickly, this isn’t always instant like it is with a bank savings account so make sure you understand what you are investing in and how you can get your money back.
So, should you consider P2P?
My view is that P2P is definitely worth considering. There are risks involved so savers shouldn’t put all their money in to P2P but it is worth considering putting in a proportion – perhaps something like 5 – 15%. Savers who are debt free and willing to take some risk over the longer term may want to considering trying it out by putting in small amounts initially to get used to it.
If you are interested in finding out more, the two largest firms, who are both members of the Peer to Peer Finance Association, are worth having a look at:
Zopa lends money to individuals wanting personal loans and offers projected returns of 4% in its ‘Core’ product and 4.6% in its ‘Plus’ product and savers can invest from £1,000.
Funding Circle lends to businesses and has an autobid system which spreads your money across a wide range of borrowers. It has two products, Conservative and Balanced which have projected returns of 4.80% and 7.20% after fees and bad debts.
There are a huge number of smaller firms also worth exploring including Proplend, who offer projected returns of 5% - 12% on property lending and Market Invoice, who lend money on invoices and loans to British businesses.