With peer-to-peer loans, borrowers can get funding without having to go the traditional route. Instead of borrowing from banks or building societies, they can borrow from people or businesses.
What is peer-to-peer lending?
Peer-to-peer lending, also known as P2P, is a method of securing a loan by pairing up a borrower with a suitable lender. This arrangement bypasses the need for a bank or building society by connecting investors to their borrowers more directly.
P2P lending usually involves the borrower detailing the amount they want to borrow, how long they need the money for, and how they would use the loan. Most P2P lending platforms are online so decisions can be instant if there’s a lender that fits the bill.
As a lender, you have the choice of one borrower to lend the money to, or alternatively you simply lend out the money and it’s shared between multiple borrowers.
P2P loans are either secured or unsecured, depending on the arrangement between the lender and borrower. Unsecured loans are paid back by the borrower, but the lender isn’t protected if repayments are not made. Secured loans involve the borrower putting up assets against their loan as collateral, which the lender can claim if re-payments can’t be made.
What should I consider before I invest in peer-to-peer lending?
If you are thinking of investing in a P2P loan, there are several factors to consider to be sure it’s the right option for you.
Who are you lending to?
It’s helpful to understand who you’ll be lending money to when deciding whether to invest in P2P lending. Borrowers can be individuals or businesses from all sectors.
Online platforms will usually credit check their borrowers before loans get approved, which adds a layer of security to the process. Be sure to research the P2P lending platform you are considering – it will help you to understand their screening process and who you may be lending money to.
Is your money protected?
It’s important to know what will happen to your money in the worst-case scenario.
If the borrower cannot pay back the loan, you may be provisionally covered by your P2P platform to make up for missing payments. However, this is not always the case and you may not get your promised return back in full.
If the peer-to-peer platform itself was to go into administration, you may still get your money back, providing the borrower can still meet their payments, however this is not guaranteed.
Are there fees involved?
Most peer-to-peer lending companies in the UK have fees, which contribute towards the running of the platform. Some fees may take a percentage of the returns to add to a provision fund in the case of your borrower failing to make re-payments. Remember to review your chosen platform to find out what fees they charge to make an informed decision.
Peer-to-peer lending advantages and disadvantages
Peer-to-peer lending is a fast-growing market, with lending platforms growing steadily year after year. However, P2P lending isn’t for everyone and there are significant advantages and disadvantages to consider before you agree to anything.
Advantages to peer-to-peer lending
- P2P loans have the potential to bring in profit quickly, with loans being fairly short-term.
- Lenders can choose the level of risk they are willing to take on their investment.
- P2P lenders also have the flexibility to decide on the amount they want to invest.
Disadvantages to peer-to-peer lending
- There is no guarantee the lender will get their money back if the borrower becomes bankrupt.
- Lending platforms often have fees which can be significant.
- Many platforms don’t allow borrowers or lenders to withdraw their funds or profit early.
- P2P loans aren’t covered by the Financial Services Compensation Scheme (FSCS). However, many lenders do have procedures in place for reimbursement.
How safe is peer-to-peer lending?
While there are risks involved with P2P lending, many lending platforms can take extra steps to protect investors. For added peace of mind, look for P2P lending companies that have successful track records for paying back lenders if they don’t get their promised return.
Always check your chosen platform is regulated by the Financial Conduct Authority (FCA). The FCA regulates financial firms and markets in the UK, and introduced peer-to-peer lending rules to prevent harm to investors.
Despite the steps lending companies can take to become more secure, there is always a risk that you won’t get your investment back in full.
What are the alternatives to peer-to-peer lending?
If you are looking for a loan but don’t think P2P loans are the right option for you, there are plenty of alternatives.
- Overdrafts – are pre-arranged with your bank and allow you to spend more than the balance in your account. Overdrafts need to be re-paid and usually with added interest.
- Guarantor loans – require a friend or relative to sign as guarantor before the loan is accepted. Your guarantor will be responsible for any debt if you are unable to re-pay the loan.
- Credit cards – similar to an overdraft, credit cards allow you to spend more than the balance in your account, which needs to be paid back regularly – usually monthly. Failure to make these payments can lower your credit score.
- Short-term loans – allow you to take out larger amounts of money to be paid back quickly. They are known for their higher interest rates, and are to be paid back within months.
- Debt Consolidation – can be used to pay off high-interest debts. They are beneficial if the interest rate of the consolidation loan is lower than that of the existing debt.
Should I try peer-to-peer lending?
Peer-to-peer loans have plenty of upsides if you’re looking for a relatively short-term loan. Whether you are a lender looking to make some profit or a borrower with a business venture, P2P loans have the potential to provide money quickly.
Whatever you decide, thoroughly research your lending platform before committing so you can make the best decision for you and your situation.
For more advice on borrowing, visit Norton Finance Know How.