Peer-to-peer lending (P2P lending) is the practice of borrowing and lending money directly to other people, individuals and institutions. This can be done through online platforms and bypasses banks, giving borrowers lower interest rates and investors higher returns than they would get from a bank. P2P sites effectively act as matchmakers between borrowers and lenders, providing transparency to the lending process.
Some well known international players include P2Pincome, MarketInvest, MoneyThing, Assetz Capital. In the UK the sector is currently unregulated by the Financial Conduct Authority (FCA).
Some of the biggest P2P players have now formed a trade body, The Peer-to-Peer Finance Association, which aims to raise standards across the sector.
There is growing demand for P2P lending as borrowers and lenders seek alternatives to traditional finance. But there are risks involved in investing in peer-to-peer lending. Before you decide to start investing in P2P lending let’s take a proper look at what it is.
What is peer-to-peer lending?
Direct Lending: This kind of P2P lending doesn’t pass through a bank, giving borrowers an alternative source of finance and investors greater returns than they would get from a bank. It helps to bypass banks, giving borrowers lower interest rates and investors higher returns than they would get from a bank.
Many platforms are websites which operate in different ways. Some require borrowers to apply for loans, while others allow lenders to browse loan requests and choose the ones they want to invest in. Getting your money back can be at risk if there are not enough investors to cover the interest on the loans. That means it is best for investors with a long-term investment horizon and who are happy not to touch their capital.
How does peer-to-peer lending work?
Finding a loan: Some sites allow lenders to browse loan requests and choose the ones they want to invest in, while others operate on a model whereby borrowers have to apply for a loan and go through a credit check. Investors select the loans they want to back by choosing a rate, duration and whether they want their money returned as a lump sum or in stages, plus an element of risk on how likely the borrower is to repay their loan.
Repayments: After periods ranging from six months up to five years, investors receive regular interest and capital repayments. Loans are secured against a borrower’s property in much the same way as a traditional mortgage through a second charge loan. If borrowers don’t repay their loans, the P2P site will sell the house to recoup some of its losses. Investors can also opt to receive their money back by choosing a lump sum or in stages.
Income generated from peer-to-peer lending is likely to be treated as interest and be taxable, but it is possible to offset the costs against your income tax. It may also be possible to take advantage of corporation tax reliefs, if you run a company. However, the tax treatment of peer-to-peer lending is currently unclear and HMRC has indicated it will issue further guidance shortly.
Before starting, there are a few sensible things to check:
1) What safeguards do platforms have in place?
2) Do you understand the risks involved?
3) Can I afford not to touch my capital?
4) Do platforms comply with FCA regulations?
5) Can I afford the charges they will take on my investment ?
The main risks of peer-to-peer lending are:
1) That your capital is at risk if borrowers don’t repay their loans or you fall victim to fraud.
2) There is no guarantee that you will get your money back . If a platform goes bust or its website stops trading, there is no FSCS protection.
3) Interest rates are not fixed and may vary over time.
4) Each P2P lending site has different rules on how it operates and the tax treatment of the interest you receive.
Revenue for lenders
For lenders, there’s potential revenue from p2p lending investment. P2P lending provides an amazing opportunity to make money, but it is definitely not easy. You have to have a lot of patience if you want to make any respectable amount of money doing this. The first thing you need to realize is that making money P2P lending is all about the note selection. The second thing you need to realize is that there is no perfect strategy for finding good notes. Everybody has their own idea of what makes a great note and nobody can agree 100% of the time on what makes a note great or not.