Peer To Peer Lending ExplainedWritten on April 29, 2014 by Kirk Rice LLP
Financial Services QuestionsThe Question:
I see that ISAs can invest in peer to peer lending. I have read that these are good and I’d like to know more. I have poor interest rates on my Cash ISAs.
Kirk Rice LLP answers:
You put your savings in a UK Bank and it pays you interest. The Bank then lends your money to borrowers. As a depositor, you are assured of, up to £85,000, if the Bank goes bust. Traditionally businesses would also go to a Bank and borrow to fund growth, buy equipment and premises. Over the last decade or so, increasingly stringent Regulatory Standards required Banks to protect the banking system from failure by building up capital reserves. This led to a general reduction in the money available to lend and when they did, increased interest rates to reflect the level of risk. This environment led to new lending opportunities. Peer to peer lending introduces lenders, maybe you, directly to one, or better still, a number of borrowers. Each scheme operates differently and the size of loans can be from a few hundred pounds.
The matching process means your money will start to earn you interest when loans are made. You should ask what the costs are and what happens in the event a debtor defaults and who meets the expenses. The providers generally do not have the Cash reserves that Banks have and any financial shocks or cash flow issues might put the firm out of business. Peer to peer providers have to hold insurance for this to ensure an agency can be employed to administer and pursue any debts on your behalf. Peer to peer providers are Regulated by the Financial Conduct Authority so you can expect information and risks to be clear.
However, unlike Deposit Accounts, there is no Compensation Scheme. The interest rates will be very attractive compared to normal Deposit Accounts, but they are clearly not comparable products. A traditional way to lend to companies has been to pool your money in investment funds that buy Corporate Bonds. Bonds are issued by listed companies as an alternative source of funding their growth. Listed Companies are widely researched and publish regular updates to enable them to be classified into bands of risk and reward. If an investment company goes bust you are protected by the Financial Services Compensation Scheme up to £50,000. The recent change to include peer to peer lending into ISAs does mean you will see more about them in the media. You need to consider if you are comfortable taking risk with this money. If you cannot afford to lose it you should continue to do your best with available deposit accounts.
If you would like more advice regarding this issue or any other financial services matter, please contact us.
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The value of investments and income from them may go down. You may not get back the original amount invested. Some funds will carry greater risks in return for higher potential rewards.
Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made.
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