When you need to borrow money, there are always several options available to you. It’s important to understand the range of choices so you can pick the best one for your situation. In the last decade or so, peer to peer lending has taken off as a popular way of borrowing money for both borrowers and lenders.
Lenders profit from higher interest rates by lending their money rather than saving it, while borrowers may get a better deal from peer lending compared to high street loans or payday loans online. However, there are risks with peer to peer loans, as with any loan or investment. Cashfloat explores how peer to peer lending works along with its pros and cons so you can make an informed decision when choosing a lender.
What is Peer to Peer Lending?
Peer to peer (P2P) lending allows ordinary people to lend their money to other ordinary people. P2P websites give you a platform to match up with a lender or a borrower, depending on what you need. They give you the tools you need to create a lending agreement and get a good deal on a loan or make a higher return on investments.
People often use P2P lending to save their money instead of using a regular savings account. However, the rate that peer to peer lenders charge is still low compared to other loans. This is a great benefit for borrowers and encourages them to try P2P lending over other options.
The Risks of Peer to Peer Lending
If you’re considering peer to peer investments, you need to understand the risks clearly. As an investor, one thing to be aware of is that you won’t have the same protections as if you used a bank or building society account for your savings. The Financial Services Compensation Scheme doesn’t cover P2P lending.
The loss from borrower defaults will often fall entirely on the investor. Using P2P lending to invest your money involves risk, just like almost any other type of investment. There is always the chance that you could lose money, and you must be prepared to take that risk.
But what about risks for borrowers? If you’re considering P2P lending, the risks aren’t as significant compared to other loans. In comparison to personal loans from banks, there is no major difference in risk. It’s easy to compare your loan options based on the interest rates available to you.
However, it’s also important to look at the fees you may have to pay, as they can vary depending on your credit score, the amount you want to borrow, and the loan terms. When considering taking out a loan, it is vital to take all of these factors into account, as they control the ultimate amount you’ll have to repay.
What Safety Nets Exist for P2P Lenders and Borrowers?
It’s always beneficial to have protection when you invest or borrow money. Although the FSCS doesn’t cover P2P lending in the same way as traditional loans, there are still some protections in place. For example, the FSCS for investors does protect you if you lose money through P2P investing because of bad advice from a financial adviser. You might be able to claim up to £50,000 if you lose money due to bad advice.
Investors might also be protected through the P2P company itself. While many peer lending companies pass a loss onto the investor, not all of them do. You can select a website that has a provision fund designed to help cover bad debts. The fees paid by both borrowers and lenders often contribute to creating and maintaining this fund. It provides a safety net for both investors and borrowers and gives both parties a greater sense of security.
Many sites also take steps to ensure that potential borrowers are capable of repaying their debts. This includes credit checks, which benefit both sides by helping lenders avoid giving a loan to a borrower who can’t afford it and landing investors with bad debts.
The Rewards of Peer to Peer Lending for Lenders
Of course, there are several potential rewards of peer-to-peer lending for both investors and borrowers which make P2P lending an appealing alternative to traditional loans. For investors, the potential for higher returns on their investments is very attractive. Peer-to-peer lending offers investors better returns than traditional saving, amounting to average gains of around 3.5%. If they are willing to take higher risks, they can potentially even double their profits.
In April 2016, the UK government introduced the Innovative Finance ISA (IFISA) account, which upped the ante for the peer to peer lending UK market. The IFISA is a type of investment account which allows P2P lenders to accrue tax free interest on their money, adding significantly to their gains. This is a great advance for both for investors already operating on p2p platforms and potential investors who are contemplating it.
P2P Lending Perks
Potentially Higher Returns
Accrue Tax Free Interest
Gradual Introduction to Investing
Furthermore, many people are unhappy with the rates of interest they receive from conventional savings accounts. However, they may be wary of trying more complicated forms of investing. Peer lending can provide a gradual entrance into investing for new or timid investors and help them build confidence in making their money grow.
P2P Lending Benefits for Borrowers
For borrowers, the main reward of P2P lending is finding better rates. Interest on your peer loan could be significantly lower than on a traditional short term loan. In fact, from the borrower’s point of view, the process is similar to borrowing from a bank.
They can be cheaper to repay as you can often make early payments without any fees. Additionally, there is usually no minimum amount you must borrow, so you can borrow exactly as much as you need. As long as borrowers take the time to understand costs and other relevant factors, peer to peer loans can be an excellent deal.
When Should You Consider P2P Lending?
Peer to peer lending can be an excellent option to consider both as a lender and a borrower. If you want to invest your money, P2P lending could be a good way to help you grow your savings. If you’re considering it as an option, the most important thing to remember is that you are taking a risk.
Although you might receive better returns, you could also lose money. If you’re willing to take that chance, peer to peer lending could be suitable for you.
As a borrower, peer to peer lending might work for you. It’s especially useful if you’re looking for loans with better interest rates. You may find it easier to secure a great loan if you have a good credit rating. But they can also provide another avenue if banks have rejected your loan application.
Peer to peer lending can be a great way to both borrow and make money. But before you decide if it’s right for you, make sure you look at it from every angle.