This is a Part 2 of a Guide we are creating in the IntelligentHQ Series on Collaborative Finance. Collaborative Finance is an umbrella term that assembles together various processes of money exchange happening right now that are revolutionising finance. In the second part of this series we will look at Peer to Peer Lending.
Peer to Peer Lending
Peer to peer lending is a relatively new approach to finding money to advance projects, and it has also been termed as “crowd lending”. There are websites of this genre springing up all over the place and understanding them can be helpful, especially for people that are looking to invest and make some money, or those that need to borrow some money and want to go through alternative means other than a bank. One of the great advantages of peer to peer lending for the borrower is that rates tend to be lower because there is no institution (such as a bank) sitting in the middle. The websites that offer peer to peer lending solutions charge a fee and make their money that way, and savers or investors benefit from better rates.
As Martin Lewis of Money Saving Expert explains:
“Lending isn’t willy nilly though; borrowers are cherry picked by credit checks and rated according to risk.”
Additionally, the websites carry out all of the repayment chasing, which makes it somewhat of an easy option for investors/saver, asserts Martin Lewis. Of course, peer to peer lending is not without its risks and those that are lending should be aware of those before they get started. Lewis recommends starting off small “until you’re used to it”, as well as gaining an awareness of the different ways in which the different sites work so that there are no nasty surprises.
Martin Lewis explains that with peer to peer lending, tax is paid like savings. The interest that is derived will be taxed as income tax, the same way in which it would for normal savings. Savers or investors that use these sites will pay tax on all of the interest that they are paid, regardless of whether there are bad debts as well.
The following video, explains us what is peer to peer lending:
Looking more closely at the risks, one of the main ones that Martin Lewis outlines is the fact that there is a chance of not getting repaid. The different sites all have different kinds of approaches to try and reduce this risk, so Lewis recommends exploring these and understanding them properly before selecting a site to lend through. However, there are also some other considerations. One is that cash might not be lent immediately and in this case it will not earn any interest while it is sitting there waiting to be lent to someone or an organisation. There are also no savings safety guarantees. Lewis describes how in the UK generally speaking there is a Government-backed Financial Services Compensation Scheme. With this, individuals will get the first £85,000 of their UK savings back per financial institution if the institutions fail. However, this is not something that peer to peer lending sites benefit from. Another definite risk is that if the site ceases doing business you will be responsible for getting the money back from the person that it was lent to. This could be very difficult to achieve in reality.
Lewis reviews some of the peer to peer lending websites that have sprung up. One of these is Zopa, which is a site that has been running for the longest (since 2005). On this site there are 52,000 lenders and £550 million has been lent so far. The website spreads the impact of bad debts across all savers and uses a Safeguard fund to achieve this. Lenders through this site get paid back monthly, but if you need your money back urgently you will have to wait three to five days and pay a 1% fee on it. Ratesetter is another option and at the current time over a five year period it offers better rates than Zopa. It uses a Provision Fund that is similar to the Zopa Safeguard approach. So far the organisation has lent £252 million and there are 13,248 lenders. A third option reviewed by Lewis is Funding Circle. This website has lent £290 million so far and has 30,000 lenders active on its site. You choose how to mitigate your risk by lending over the number of businesses that you choose to, however, Funding Circle recommends that lenders spread their risk by lending to a minimum of 100 businesses. Working with this site, if you need your money back quickly you can get it back in a day for a 0.25% fee.
Guide to Collaborative Finance (part1) – What is Collaborative Finance
Guide to Collaborative Finance (part2) – Peer to Peer Lending
Guide to Collaborative Finance (part3) – What is social saving
Maria Fonseca is the Editor and Infographic Artist for IntelligentHQ. She is also a thought leader writing about social innovation, sharing economy, social business, and the commons. Aside her work for IntelligentHQ, Maria Fonseca is a visual artist and filmmaker that has exhibited widely in international events such as Manifesta 5, Sao Paulo Biennial, Photo Espana, Moderna Museet in Stockholm, Joshibi University and many others. She concluded her PhD on essayistic filmmaking , taken at University of Westminster in London and is preparing her post doc that will explore the links between creativity and the sharing economy.