Money Mondays – Introduction to Peer to Peer Lending

Each week, I will bring you a new guest post in the series “Money Mondays”. Today’s post is from Lewys The Frugal Student.

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Interest rates right now suck. Weve even had to endure a further Bank of England base rate cut this past year after the Out vote. On top of this, inflation is now at 3% a year meaning that any cash you hold is increasingly worth less.

If youre like me, then youre fed up of these depressing returns and are looking to boost your returns. Youve looked at the bank accounts on offer but arent impressed and are not prepared to take on the risk of stock market investing.

Well, I may just well have the answer!

Peer to Peer lending

Peer to Peer lending can offer returns of as much as 12% although this comes at the price of significant risk. Put simply, peer to peer lending is the act of lending your money to borrowers through an online platform. In return for lending your money to borrowers the platform will give you a percentage of the interest charged to the borrower as a return. The most popular platforms minimise the risk of a lender encountering large bad debts by splitting a lenders investment over several borrowers (often tens to hundreds). 

In this guest post Ill tackle the following most common questions surrounding peer to peer lending in order

How risky is peer to peer lending?
How much can I realistically earn from peer to peer lending?
How do I start peer to peer lending?

How risky is peer to peer lending?

The question of risk is of course a subjective one.

For example, peer to peer lending is rightly considered moderately risky to compare with a savings account but is considered much less risky than investing in individual stocks and shares.

Personally, I dont consider peer to peer lending that risky due to the large contingency funds platforms now used to back lenders. I know many people will disagree citing the fact that a total loss is possible in the event of a catastrophic economic downturn – definitely possible whilst considering uncertainty surrounding Brexit.

To reduce risk, I would recommend sticking with the more well known platforms that have larger contingency funds such as Zopa, Funding Circle or RateSetter.

As anything, returns are usually linked to risk. The higher the return, the riskier the investment and as such the higher returns of over 6% are usually reserved for those lenders willing to take on substantially more risk.

As a quick example, Zopa offers returns of 3.7% for investments across their safer core marketand 4.7% for investments across their (higher risk) markets.

How much can I realistically earn from peer to peer lending?

If we take the main three platforms, we can see that the amount one can earn from peer to peer lending varies not only by risk, but more commonly by the time one is willing to lock their money up for.

Ratesetter is currently offering;
*3.1% annual returns on a rolling market basis meaning that you can pull out your cash at any time
*4.2% if you lock up your cash for a year (penalties apply for early withdrawal)
*5.6% if you lock up your cash for 5 years (penalties apply for early withdrawal)

Funding circle on the other hand advertises a projected annual return of 7.5% (after bad debts and fees). Although this will be significantly less if you get burdened by many bad debts.

Answering the question of how much one can realistically make from peer to peer lending is difficult as it is highly dependent on risk tolerance. For the conservative investor willing to lock his/her cash up for a year with the comfort of a contingency fund, 4.2% is comfortably achievable.

For those seeking to earn a much higher return should look towards platforms such as Funding Secure which secures loans against borrowerspersonal assets, such as jewellery, and offers lenders returns of up to 13%. Although clearly, this is substantially higher risk.

How do I start peer to peer lending?

Luckily P2P lending sites are now a lot more straight forward than they used to be. Most now feel just like a bank account!

If youre looking to start peer to peer lending then Id recommend setting up an account with Ratesetter and opting for the one year account. You simply open an account, deposit your money and wait for Ratesetters platform to lend the money for you.

Once you get the hang of Ratesetter and how it works, you can experiment with higher return platforms such as Lending Crowd which lets you self-select investments.

One thing to keep in mind though is that platforms have been slow to launch their promised ISA accounts and as such most platforms still only offer classicaccounts. As a result, anyone earning above £1,000 in interest is liable to pay tax.

If youre looking to open an ISA account and dont mind investing in the stock market then I highly recommend you check out my Nutmeg Investment Review. If youre looking to invest in the stock market then you should start with my complete guide to investment strategies.

If you have a blog yourself and want to take part in this weekly series, get in touch and let me know your ideas.

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