Last updated: 04/09/2020 | Estimated Reading Time: 4 minutes
Over the last few years, the peer-to-peer lending industry has taken off in a big way, with many people fed up of dealing with large financial institutions start to search for new, innovative ways to save and to borrow.
But what exactly is peer-to-peer lending? And is it a true alternative to conventional means of saving and borrowing?
Read on to find out.
In This Guide:
- What is peer-to-peer lending and how does it work?
- Peer-to-peer lending companies
- Borrowing through peer-to-peer schemes
- Saving with peer-to-peer schemes
What is peer-to-peer lending and how does it work?
On the face of it, a peer-to-peer (P2P) loan is just like any other unsecured loan – you set an amount you wish to borrow which you then pay back, with an agreed rate of interest, over the course of an agreed term.
The difference lies in where you actually borrow the money from.
Instead of approaching a bank or building society or other established financial institutions, you approach a P2P company that essentially acts as a middle man between you and another individual (or group of individuals) who have put money up themselves.
As such, people use peer-to-peer schemes both to save (by investing), and to borrow.
The advantage is in the avoidance of the need to jump through the various hoops that banks or building societies tend to set out for those wishing to borrow. This doesn’t mean that if you’ve been turned down by a bank, you’ll be able to easily get a peer-to-peer loan, but there is more flexibility afforded in the lending criteria.
Your credit rating will be looked at, and the interest rates you are offered will be determined by that and your general financial health, but given that you are requesting a loan ultimately from an individual, you can expect a higher degree of lenience.
Those wishing to lend through peer-to-peer companies can agree to lend to higher risk candidates in return for higher rates of interest on their savings, where a bank may not be willing to take the same risks.
Peer-to-peer lending companies
P2P loans are handled by dedicated companies that act as middle men.
The first peer-to-peer lending company to exist in the UK, and still the largest one active, is Zopla who, to date, have arranged more than £400 million worth of loans for over 500,000 different customers.
There are now several more P2P companies working in the UK, including (but not limited to) Funding Circle, ThinCats, RateSetter and LendInvest.
These companies exist solely online, and will charge you an administrative fee for putting you in touch with a lender, though the size of this fee can vary and it may simply be added to your interest rate, rather than charged as a lump sum.
You can compare conventional loans with peer-to-peer loans to see which would give you the best deal.
Borrowing through peer-to-peer schemes
Taking out a peer-to-peer loan is a fairly straightforward process. Simply inform the lending company of your requirements, answer questions on a short form, and after checking your credit rating they’ll respond with an offer.
The main advantages of peer-to-peer borrowing as opposed to conventional loans are the added flexibility both in terms of loan terms and in terms of whether or not you’ll be able to take a loan out at all, and more importantly, the generally lower interest rates that you can expect to pay.
Since peer-to-peer companies are exclusively online based, the overheads that they have to pay are significantly lower than those faced by larger financial institutions like banks with physical branches.
This translates into lower fees and interest rates for customers.
Generally speaking, the repayment terms set when you take out a peer-to-peer loan are flexible. Often they will have a maximum term set, but you will generally not have to pay any extra fees for early repayment, as you would when taking out a loan through a bank.
For some, a further advantage of peer-to-peer lending is simply the lack of involvement of banks – the interest paid goes to another individual (with a small cut going to the company facilitating the lending of course) rather than to a large, faceless financial institution.
It must be noted that, as with any loans, late repayment can lead to serious financial problems. For help, visit The Money Advice Service.
Saving with peer-to-peer schemes
Peer-to-peer lending is also becoming an increasingly popular option for savers looking to get better interest rates. The added risk of lending to an individual over simply leaving money in a savings account translates into better returns.
The added flexibility that borrowers can enjoy also works for lenders. If you need to withdraw the money you’ve lent at short notice, you’ll generally be able to do so by selling your contract on to another lender.
Peer-to-peer lending schemes are now (as of 2014) regulated by the FCA, however what you will not get as a saver is protection under the Financial Services Compensation Scheme which you would otherwise enjoy if you went through a bank or building society.