Is peer-to-peer lending safe? Risks & regulations
As with any financial decision, it's important to understand the risks involved before you invest in peer-to-peer lending. In this guide, we're going to give a clear and honest explanation of how safe P2P lending is, looking at:
- Peer-to-peer lending risks
- Regulation of peer-to-peer lending
- The safest peer-to-peer lending platforms
Peer-to-peer lending risks
One of the main peer-to-peer lending risks is that the person(s) borrowing your money may make late repayments or default on their loan. The chance of this happening and the consequences if it does differ by P2P lending platform.
Another risk of peer-to-peer lending is that your contributions are not covered by the Financial Services Compensation Scheme (FSCS). This means that, unlike many other forms of financial product, you cannot reclaim any money should your provider experience financial distress. However, all P2P lending providers should have orderly wind down plans in place to protect you should something go wrong.
Regulation of peer-to-peer lending
Peer-to-peer lending (also known as loan-based crowdfunding) platforms in the UK have been regulated by the Financial Conduct Authority (FCA) since April 2014, helping to ensure fairness and transparency in the industry. This also gives consumers access to the Financial Ombudsman complaints service.
- Platforms must ringfence client funds that haven't been allocated, so that they can be returned in the event of insolvency.
- Platforms must give a 14-day 'right to withdrawal' period, in which customers can end their agreement for any reason.
- Platforms must comply with capital requirements to ensure they are resilient in the event of financial difficulties.
Lending Works is also a member of the Peer to Peer Finance Association (P2PFA), a self-regulatory body which aims to "set good practice standards in the UK’s peer-to-peer lending sector". Members must follow its operating principles, which include:
- Platforms will not seek to conceal loss rates by use of their own capital to finance loans.
- Platforms must set out in a clear and balanced way the information necessary to enable customers and prospective customers (lenders and borrowers) to make informed decisions.
- Platforms shall embrace robust arrangements for credit risk management and undertake sufficient assessment to satisfy themselves that those who borrow can afford prudently to do so.
The safest peer-to-peer lending platforms
The safest peer-to-peer lending platforms use a variety of techniques to protect lenders' money and ensure they make the expected returns.
Underwriting: The stricter your platform is with who they will lend to, the lower the risk of those borrowers defaulting. However, it's important to remember that risk cannot be eliminated, as even borrowers with a good credit history can fail to repay their loans.
Here at Lending Works, our underwriting team perform credit checks, affordability checks, identity checks and fraud checks to help ensure that your money is only lent to creditworthy borrowers. Learn more about the average Lending Works borrower and how we assess loan applications.
Contingency funds: If a borrower misses a repayment, your P2P provider should take steps to recover this debt as soon as possible and prevent them from entering default. Some platforms also offer contingency funds, which means the fund will cover a certain amount of money delayed through arrears or lost through default so that lenders are not affected.
The Lending Works Shield has covered all arrears and defaults since we launched in 2014. This means that lenders have always received their expected capital and interest payments in full and on time. This is achieved through our own reserve fund and industry-first insurance, which you can read more about here.
View our risk and return statistics to see exactly how much money is currently protected by the Lending Works Shield, as well as historical arrears and bad debt rates.
Diversification: Diversification means spreading out your investment across multiple borrowers so that all your eggs aren't in one basket. This helps to average out the default rate and ensures only a small amount of your money is affected should a borrower in your portfolio fail to repay.
At Lending Works, we have an algorithm that automatically distributes lenders' investment fairly and effectively. And, in the unlikely event that the Lending Works Shield cannot cover bad debt (and our own funds cannot make up the difference), our reserve fund trustee may declare a 'pooling event' to ensure that losses are fairly distributed across all investors. Find out more.
Back-up service providers: Back-up service providers will take responsibility for the management, servicing and collection of outstanding loans should your P2P platform cease to operate for any reason. Otherwise, there's potential to lose all your investment should your provider go bust, as there's no FSCS protection.
Lending Works has appointed Link Financial Outsourcing Limited as its third-party back-up service provider. Further details can be found in section 27 of our Lender Platform Terms & Conditions [PDF].
So, is peer-to-peer lending safe? Like any investment, it does put your capital at risk. However, given the predictability of the repayments from borrowers and other safeguards in P2P, other forms of investment are often risker. Whereas, below-inflation interest rates mean low-risk savings accounts can effectively lose you money over time. That makes P2P lending a sensible way to grow your cash.
It's also important to remember that the risk level differs greatly depending on the P2P platform you choose. The Lending Works Shield has made investing with us rewarding since day one, and we thoroughly intend it to stay that way. Don't hesitate to get in touch if you have any questions.
It is important that we highlight that with any peer-to-peer lending platform, your capital is at risk.