How to navigate the world of peer-to-peer lending
Peer-to-peer (P2P) lending – where investors directly fund loans to people, small businesses and property borrowers – has experienced strong growth in recent years due to the fallout from the financial crisis and the opportunities created by technological development.
In some cases, cash ISA savers are losing money where inflation exceeds the interest rates on offer. In addition, many are frustrated by the uncertainty in stock markets, which in a lot of instances produced losses in 2018. For example, the FTSE 100 index dropped 12.5% in 2018.
P2P lending, on the other hand, is a fundamentally different asset class which has largely delivered on its promises of providing investors with stable, predictable returns.
Zopa was the first P2P lender, starting way back in 2005, aiming to be an “eBay for money,” and has been joined by big brands such as Funding Circle and RateSetter in the past decade.
Nowadays, investors can put money into loans backing a range of assets: from consumer, to business finance, to property. In most cases, this can be done within a tax wrapper using the Innovative Finance ISA (IFISA), which allows investors to enjoy tax-free earnings on their P2P investments within their £20,000 annual ISA allowance.
Several platforms offer IFISAs, while a number of companies also allow you to invest across a different P2P platforms, lending sectors and a large number of borrowers, spreading both money and risk within the tax-free wrapper.
What are the risks?
Some investors automatically compare P2P with savings products because the offerings look and feel similar to pre-crisis savings rates. However, P2P investments hold an extra layer of risk for the returns on offer and P2P should be considered separately from cash savings.
P2P is an investment – and as with all investments, due diligence is vital. Just as no stock is the same in the equity market, every P2P platform is different, and loans will be originated in a different way across lenders.
The biggest risk is not that a single borrower defaults, but that a large number of them default as this could consume an investor’s interest and, ultimately, affect the capital too.
It is also necessary to ensure the platform itself is stable, so due diligence and spreading the risk are important. Ultimately, it is not a question of one type of ISA or the other. Diversification is key to building a balanced portfolio.