Peer-to-peer lending (P2P)
Peer-to-peer loans – or P2P loans as the term is commonly abbreviated – are loans where individuals directly lend to other people or businesses without using a bank as an intermediary. This type of lending owes its growth to the internet, which has reduced transaction costs significantly, and to the financial crisis which has made banks much less willing to lend.
P2P finance includes both debt (peer-to-peer loans, invoice finance, mini-bonds etc) and equity (equity crowdfunding) products.
P2P loan types
Loans to businesses
Traditionally, small businesses have relied almost entirely on banks for funding. In recent years, however, this has changed with banks significantly tightening their lending criteria. A growing number of businesses are therefore exploring alternative sources of investment – one of which is peer-to-peer lending.
Business P2P platforms such as Funding Circle have made it much easier for individuals to lend to businesses:
- Lenders deposit funds and bid to lend to businesses seeking investment
- The businesses are classified by risk level and lenders can choose the level of risk they are willing to accept
- With minimum loan amounts of as little as £20 per business on some platforms, individuals are able to diversify their investment across many different businesses further reducing the risk
At the time of writing, even allowing for the platform’s fees and any defaults, lenders can get a higher return on their investment from P2P lending than they can with a bank savings account.
Loans to people
Creditworthy individuals can now get competitive access to finance via P2P platforms such as RateSetter and ZOPA. These allow you to receive attractive rates of return by lending to other people rather than to businesses.
Typically a lender lends money in small amounts to a number of other people via a platform. By spreading their lending across multiple borrowers the lender is able to reduce their risk. In return, they receive monthly repayments of capital and interest. The P2P platform makes money by charging a small fee.
Asset-backed vs non-asset-backed P2P loans
Asset-backed peer-to-peer loans are the newest type of P2P lending. In this case, individuals invest against an asset or assets held as security in order to get back their capital plus interest. An example is a car leasing scheme where investors invest in cars through a P2P platform (e.g. Buy2LetCars.com). Customers then lease the cars, paying a monthly fee to the investor.
Depending on the platform, such assets can include jewellery, art and classic vehicles. Even items from the Titanic have been used as collateral, according to FundingSecure.com.
Asset-backed lending is theoretically more secure than non-asset-backed because if the borrower defaults, the P2P platform will sell the asset and use the proceeds to repay the lenders their capital and interest.
Returns vs savings accounts
Even allowing for the platform's fees and any defaults, lenders can get a higher return on their investment from P2P lending than they can with a bank savings account.
One of the P2P platforms lending to individuals currently advertises an annualised return of 5.0% over five years after allowing for a 1% platform fee and defaults, and before tax. Similarly, another business P2P lending platform currently advertises an annual return of 7.4% – again before tax and after deduction of fees and allowance for bad debts.
The best five-year fixed rate savings account rate is just 3% from a bank before tax.
In the news
In December 2014, the Chancellor George Osborne unveiled a package of measures boosting the P2P lending industry. This includes a new bad debt relief to allow individual investors to offset any losses; from April 2015 they will be able to make a claim for relief via the self-assessment system.
What are the risks?
Debt crowdfunding such as peer-to-peer lending carries inherent risks that the borrower may default and therefore investors may not get back all the money they invest.
P2P lending platforms take steps to minimise the risks by, for example, credit-checking borrowers and chasing missed payments. Investors can minimise their exposure to risk by diversifying their investment across multiple individual or business borrowers or by investing only in those borrowers with the lowest risk level.
Alternatives
Of course, there are alternatives to P2P lending. Here are just a couple.
Mini-bonds
A number of well-known companiesm including John Lewis and Hotel Chocolat, have used mini-bonds to raise debt-based finance. Mini-bonds typically have terms of three to five years and pay out regular interest payments. However, the bonds must be held until they mature and cannot be cashed in early.
Equity crowdfunding
An alternative to debt-based investing, such as P2P loans or mini-bonds, is equity crowdfunding. With this, investors invest in unlisted companies and in exchange receive shares in those companies. Visit our equity crowdfunding page to learn more.
SyndicateRoom offers a unique form of equity crowdfunding: members invest in early-stage and growth companies alongside experienced business angels.
Membership of SyndicateRoom is free, join now to see all of our investment opportunities.