If you’re looking for an investment option, it’s very likely that you’ve stumbled across peer-to-peer lending. A viable and interesting instrument, it can also be confusing to the uninformed, which is why you want to do your research before making any important decisions.
To help you out, we’ve created this handy guide for you to have a read through. Explaining what peer-to-peer investing is, how it works, and if it could be a suitable choice for you, we hope that you’ll find it invaluable…
What is peer-to-peer lending?
The best question to start with is this one: what is peer-to-peer investing? Essentially, it is an instrument that matches savers who are willing to lend with borrowers in need of financial aid, through the use of specialist websites.
For the former, it is an effective way to secure better rates than those offered by banks, but do not be fooled into thinking that this makes it right for you. As ever, higher rewards equate to a higher level of risk, and you can struggle to get your money back if borrowers fail to repay their debts.
Why should I consider peer-to-peer investing?
As we briefly explored above, the main draw of peer-to-peer lending for investors is that rates are often better than those offered by banks, which are at a rock-bottom low right now.
With savings accounts and cash ISAs often struggling to beat inflation, many believe it is worth increasing their risk level in order to obtain this improved rate of return.
Indeed, for those who choose wisely, the risks needn’t be excessive, which can arguably make peer-to-peer lending seem like the better choice. Many sites function in a not dissimilar way to banks, with some even offering safeguards to lower the risk of you losing your money should you decide to invest in them.
What are the risks?
You can see the many benefits associated with peer-to-peer investing, so now let’s look at the risks in a little more detail so that you can come to a fully informed decision.
We know that cutting out the middleman and removing the overheads of traditional banks can enable these websites to offer favourable rates, to both lenders and borrowers, but they do pose substantial risks to your capital.
The foremost of these is the risk of the borrower defaulting. Should they fail to repay what you have lent them, you could lose your capital. This is a danger that is managed in different ways by different sites, so although it’s always a possibility, it shouldn’t put you off peer-to-peer investing in and of itself.
In fact, sites like Zopa and RateSetter do offer compensation funds which lenders are entitled to if the borrower does default. However, these are not infinite and should lots of individuals fail to repay their debts at the same time, it is possible that the pot could be left empty.
What should I watch out for?
If you are considering becoming a lender, we suggest adopting an informed approach to get the most out of your investment:
- Begin by weighing up the risk of losing some or all of your money, bearing in mind that this will be significantly reduced if you use a website that has a compensation fund in place.
- You might also want to consider whether the site allows you to withdraw funds early, as it can be risky to have all of your money tied up indefinitely and no way to access it in case of a financial emergency.
- Don’t forget to also factor in how tax will impact your earnings. Peer-to-peer lending is taxable as income, although the innovative finance ISA can change this. Introduced in April 2016, it allows investors such as yourself to set up your ISA with an individual platform so that the interest you earn is not chargeable.
What is a peer-to-peer investment ISA?
As we explained above, those who wish to partake in peer-to-peer investment may find it beneficial to explore opening an innovative finance ISA. This allows you to include the loans you make in your stocks and shares ISA allowance so that you can give it a go without having to pay tax on your earnings.
Unfortunately, the downside to this is that only a small minority of peer-to-peer lending companies have the necessary regulatory permissions to offer such an ISA.
It is likely that by the end of 2017, a higher number of IFISA providers will have entered the market, meaning more competition for your funds.
If you’re considering how to invest your money, peer-to-peer lending is certainly worth exploring. Offering greater returns than many alternative investment instruments, it carries potential rewards that can be extremely appealing to those who are unafraid of running a slightly higher risk. Could it be the right option for you?