Lender guides

The ultimate guide to your first P2P investment

So, you’ve heard about all this peer-to-peer (P2P) lending ‘stuff’, and you’ve had your interest sufficiently piqued such that you’re now toying with the idea of dipping a toe in the water. After all, by cutting out financial institutions like banks, ordinary people can now benefit from excellent rates of return by lending their money directly to creditworthy borrowers who, in turn, get flexible loans with competitive APRs as a result.

But before you get your bank card out and part with your hard-earned money, you want to be sure you’re doing the right thing. We understand the importance of this decision, which is why we’ve put together our 'ultimate guide' containing five important questions you should be asking when choosing your P2P platform…

1. How safe is my money?

This is arguably the most important element when lending money through a P2P platform. It’s vital to remember that in the event of borrower default, a lender’s capital is not covered by the Financial Services Compensation Scheme (FSCS). Most P2P lending platforms have measures to counter this, and typically have a reserve fund in place to cover any defaults. Some also have other innovative ways of protecting lenders such as security or insurance. But you should always check the actual default rates of the platform versus the industry averages, as this will give a good indication of both the creditworthiness of borrowers being approved for loans, and the quality of its credit underwriting and risk management.

It’s also worth noting that platforms need to be regulated by the Financial Conduct Authority (FCA), which requires that they have arrangements for an orderly rundown of their loan book in the unlikely event the platform ceased to exist. In most cases this would mean a third party assuming control of the loan book in the event of liquidation, so that debts from borrowers remain due and collectable and payments are distributed to lenders as normal.

How safe is your money?

Questions to ask yourself about the platform:

  • Does the platform have a provision fund or other protections to cover arrears and defaults?
  • How does the level of actual and expected defaults compare to the strength of the reserve fund?
  • What, if any, other safety measures do they have in place?
  • Who am I lending to, and how stringent is the underwriting process for borrowers?
  • What happens if the company ceases trading? 

 

2. How much will I earn?

This is the big appeal of peer-to-peer lending, especially with Britons having been subjected to such poor rates of interest since the recession. Rates of return typically depend on both the platform and the length of time for which you are willing to lend, but annualised returns in excess of 4% are now commonplace in P2P lending.

And, very soon, lenders will end up with even more money in their pockets. Like any investment, income from peer-to-peer lending is taxable. But at the 2015 Summer Budget, it was revealed that the Innovative Finance ISA (IFISA) would be available to those holding peer-to-peer loans from 6 April 2016, allowing lenders to earn tax-free returns within their ISA each year. Furthermore, IFISA will be launched on the same day as the new personal savings allowance, which means the first £1,000 in interest (£500 for higher-rate taxpayers) earned by lenders on their non-ISA peer-to-peer loans will also be tax-free.

How much can you earn?

Questions to ask yourself about the platform:

  • What are the lender rates on offer versus the lending term?
  • Will I be able to set up an IFISA when they go live?
  • What are the fees involved for lenders, if any?
  • How long does it take for my funds to match with borrowers?
  • How volatile are the lender rates historically?

 

3. How compliant and/or transparent is the platform?

In 2014 the FCA put a regulatory framework in place to ensure that high standards are maintained across the industry. It is imperative that the platform you choose complies with the FCA’s regulations, while membership to both the Peer-to-Peer Finance Association (a nine-strong body of leading UK peer-to-peer platforms) and Cifas (the UK’s fraud prevention leader) are also strong indications of its legitimacy.

Membership to the P2PFA is contingent upon adherence to a strict set of ‘operating principles’, one of which relates to customer communications. There is thus a significant onus upon platforms to be as transparent as possible, and to clearly display important information like arrears, defaults, the level of lender protection and losses on their website. These are all statistics you need to assess in order to make an informed decision.

How compliant is the P2P platform?

Questions to ask yourself about the platform:

  • Is it FCA compliant? Check here
  • Is it a member of the P2PFA? Check here
  • Are they a member of Cifas, or any other anti-fraud and/or anti-money laundering agencies?
  • How visible are the pertinent statistics on the website? 

 

4. How much control do I have over my investment?

Investing in stocks and shares can sometimes resemble being in a casino – you can study the numbers all you like, but you ultimately throw your lot in and hope for the best! With peer-to-peer lending, there is the potential to have a bit more control over the money you lend. For example, some platforms give you the option to take a regular income from your investment, meaning you don’t have to wait until the end of the lending term to reap the benefits.

One absolutely crucial aspect to research is whether you are able to withdraw your money early. Personal circumstances are always subject to change, especially in a financial sense. Perhaps some unforeseen financial problems have arisen, or you need the money to make another, more attractive investment you’ve stumbled upon. Either way, you need to ascertain whether it’s possible to withdraw your money, and the costs and difficulty involved with doing so.

How much control will you have?

Questions to ask yourself about the platform:

  • Can I take my money out early if I need to?
  • What are the costs and procedure involved with doing so?
  • What flexibility and control will I have once my money is on loan?
  • Can I automatically re-lend the repayments from borrowers to maximise my return?
  • Can I take an income from my investment?

 

5. So how much should I put in?

We’d never re-hash the age-old “How long is a piece of string?” cliché, but – oh wait…oops! Yet the truth is there is no harm in starting off small, getting a feel for it, and then re-assessing later on. With some platforms, you can lend as little as £10 to get you going! Then again, the very nature of compound interest is such that the greater your capital investment, the greater the return.

Therefore, it’s a subjective question with a relative answer. One piece of advice we will offer relates to diversification. We strongly recommend that you spread your investment portfolio across multiple asset classes. But within that, whatever portion you are willing to allocate to peer-to-peer lending, we even recommend diversifying across multiple platforms. That way, you’ll be minimising risk and ensuring you end up with the rewards you deserve.

How much should you invest?

Questions to ask yourself about the platform:

  • What’s the minimum amount I can lend?
  • What portion of my investment portfolio am I looking to put into P2P?
  • Have I got enough money to spread my investment across more than one platform?
  • Does the platform diversify my money (i.e. am I lending to multiple borrowers)?

 

So there you have it – you’re just about all set to go! Of course, making a new type of investment is not a decision to be taken lightly, and we implore anyone to do their homework before making their first P2P investment. However, a steady track record and consistent acknowledgement from Government has shifted peer-to-peer lending further into the mainstream, and many consumers are benefiting from the great returns it has to offer.

Did you know... you can lend as little as £10 and start earning returns of up to 5%!

Lend your money

As with all forms of lending, your capital is at risk

Michael Todt

Mike joined Lending Works in early 2015 with a background in marketing and journalism. Having long held a passion for economics, he is now the chief contributor to the Lending Works blog, and regularly writes about all things peer-to-peer lending, fintech and personal finance.