With the prospect of a lending Isa and the ability to invest pension funds in a greater array of products, the peer-to-peer lending industry is coming under scrutiny. Ten years since the launch of the first platform, there is a host of products on offer — all with very different lending profiles and rates of return. So what are the questions you need to ask before investing your cash?
Who do they lend to?
Despite all being labelled peer-to-peer, there are vast differences in who they lend to. For instance, ThinCats lends only to small businesses which have typically been running for four to five years and have a turnover of about £1 million. Meanwhile, Zopa lends only to individuals who, in the words of its chief executive, Giles Andrews, “are stable and responsible with a proven track record of being able to manage money”.
Whether a peer-to-peer platform uses automated processes or people to decide who to lend to may also inform your decision. Kevin Caley, chief executive of ThinCats, explains that he has a network of 30 sponsors — “a group of traditional-bank-manager types who visit potential borrowers at least twice and get to know them”.
What are the risks?
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The risks are, in part, related to who the loans are given to. Those platforms that invest in start-ups and small businesses tend to have greater default rates than those that lend to individuals. However, they also tend to offer greater returns: Rebuilding Society lends to small companies with two years of filed accounts and an average turnover of £200,000; it has a default rate of 2-3 per cent but offers returns of between 14 and 15 per cent. On the other hand, Zopa had a default rate last year of 0.16 per cent and offers returns of 4-5 per cent.
The peer-to-peer industry is regulated by the Financial Conduct Authority, but it is not covered by the financial compensation scheme. This has led some platforms to build contingency funds.
James Meekings, co-founder of Funding Circle, which has a bad-debt rate of about 1.4 per cent, says: “We chose not to have a provision fund. You either have too much money in, money the investors aren’t getting, or you have too little and you are not covered. We would be introducing new risks into the lending as we try to make sure the fund has enough money in it.”
RateSetter, which had a default rate of 0.67 per cent in 2014, was the first peer-to-peer lender to ask lenders to pay a fee into a provision fund. The fund currently stands at just under £13 million and the company says that none of its lenders have lost money.
Other platforms try to safeguard losses in the same way as banks by securing loans against assets, including ThinCats, LendInvest and Money&Co.
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Mr Meekings advises that investors minimise risks by spreading their lending across multiple companies and investing over the long term.
The average Funding Circle investor has invested £5,000 in about 120 companies against an expected rate of return of between 5.5 and 7.5 per cent.
What are the returns?
The rates vary greatly from fund to fund. In many cases the rate of interest paid by borrowers, and therefore the return, is determined by the investors, who bid on how much interest they are prepared to loan against. As Julian Wells, marketing director for Rebuilding Society, admits, its returns may well come down as they accumulate more investors and so see more competition in their bidding processes.
Bear in mind whether any fees will be deducted, including payments to provision funds. You will also need to pay tax on investments, including bad debts — although the chancellor has announced that bad-debt relief will be introduced from April 2016. The peer-to-peer sector will also be given a boost if the chancellor announces that loans can be incorporated into stocks and shares Isas or in a new lending Isa (Lisa).
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How do I invest?
The amount you can invest also varies between funds — for example, the minimum investment with RateSetter is £10, whereas for ThinCats it is £1,000. Generally the longer you invest the better the rates of return, with Zopa offering 4 per cent on three-year loans and 5 per cent on five-year loans. Most investors will spread the risk across multiple borrowers, often using the platforms’ automatic bidding processes, although you can choose to invest in just one.
Find out more
A good source of information is the Peer-to-Peer Finance Association at p2pfa.info.