Peer to peer lending is an alternative investment paying higher returns than the banks to expats and retirement savers while helping individuals and businesses with their financial needs
The principle is simple – online platforms match make deals between private lenders who step in and take the place of bank and building society funding.
The result is higher interest rates on savings and less red tape and fees for borrowers.
How does peer to peer lending work?
A group of private lenders put their cash into an online platform.
The platform takes in loan applications from customers and underwrites the deal in the same way as a bank – carrying out referencing and credit checks.
Some peer to peer platforms let lenders pick their deals, while others allocate the pooled money themselves.
Do peer to peer lenders pay tax?
Yes. Income tax paid on interest earned at the lender’s marginal rate.
For example, if some lent £5,000 at a fixed rate of 6%, they would earn £300 interest.
A basic rate taxpayer would pay tax at 20% – that’s £60 – leaving a profit of £240.
A higher rate taxpayer would earn the same interest but pay double the tax, giving a £180 profit.
The same £5,000 in a bank or building society savings account would earn around 2% interest or £100, less the same tax, leaving an £80 profit for a basic rate taxpayer and £60 for a higher rate taxpayer.
The attraction of peer to peer lending for savers is obvious – roughly a 2.5 times difference in earnings
What are the risks?
Peer to peer lending comes with some risks.
First, the deal is not protected by the Financial Services Compensation Scheme (FSCS), so cash with a peer to peer platform is not protected by a compensation scheme and there is no ombudsman to challenge disagreements between lenders and platforms.
If the platform should collapse holding lender cash, the lender becomes a creditor of the company and may not get their cash back.
Next, the borrower may default on the loan. If they do, the platform should have a reserve fund with cash set aside to compensate lenders. As a last resort, the lender can take the borrower to court to reclaim their money with a county court judgment.
How are peer to peer lenders paid?
This depends on the platform and the loan agreement. Some designate monthly payments, which are ideal for investors looking for a guaranteed income, others wrap the interest up until the end of the loan term and pay a lump sum.
One point to watch is money does not earn interest until it is borrowed, so it can sit in a platform’s client account for a while without any pay back.