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Traditionally, if you needed a loan, the only option available to most of us was to talk to a bank or similar financial institution.
But today, you can tap into alternative sources of funding, including a peer-to-peer (P2P) loan. P2P lending, sometimes called social lending or crowd lending, is a way for individuals to lend money to other individuals using an intermediary. It also offers investors an alternative way to obtain a return on their money.
The P2P loan business began in the UK around 2005, offering loans to UK businesses and individuals. However, it may still be seen by many as a niche option compared with traditional lenders.
In recent years, several major players in this industry have moved away from the peer-to-peer lending model and are no longer taking on investors. Some of these brands now simply offer standard personal loans to borrowers instead.
What is peer-to-peer lending?
Peer-to-peer lending is an alternative finance option that connects individuals who want to borrow and individuals who want to lend, or invest.
Peer-to-peer platforms bring these groups together, providing an option for borrowers who want a loan and allowing investors to lend money, and hopefully get a return on their investment.
P2P lending platforms can also be an option for businesses wanting to take out a loan.
All peer-to-peer lenders in the UK must be regulated by the Financial Conduct Authority (FCA).
How does P2P work?
When you apply for a peer-to-peer loan, your application will be assessed in the same way as an application to a traditional lender.
The P2P loan platform will use a credit reference agency to analyse your financial history and establish your credit rating, or the risk involved in lending to you. If your application is accepted, it will then match you with other individuals willing to offer you a peer-to-peer loan.
If you’re interested in investing, in other words, becoming a lender, you can open an account on the P2P website and transfer the money you want to invest. You can choose the term you want to lend for and the return you’re seeking, and you may be able to split your money across many borrowers. This helps to reduce the risk that a loan might not be repaid.
Each platform will operate differently though, and offer different levels of protection to investors, so it’s important to do your research to find the right option for you.
Generally speaking, the safer the investment is perceived to be, the lower the rate of return on offer for investors.
» MORE: Should I get a peer-to-peer loan?
Advantages for the borrower
- P2P sites could offer more attractive interest rates than banks and building societies – particularly if you have a good credit score.
- Some sites may offer peer-to-peer loans to people with lower credit ratings.
- As the process is online, it tends to be relatively quick and convenient.
- You may be able to borrow a smaller amount than some other lenders.
- You can borrow money for a wide variety of purposes, including for property developments and business reasons. Platforms will set their own criteria of what a loan can be used for.
Advantages for the lender/investor
- It may be possible to access a higher rate of return than is currently available from savings accounts and bonds.
- Some sites have contingency funds to protect investors if borrowers default on loans, but it can vary considerably so it’s important you do your research.
- You can receive income from P2P lending tax free if you invest via an Innovative Finance Individual Savings Account (IFISA). You can invest up to £20,000 in an IFISA in the current tax year. This allowance is shared across all types of ISA: IFISA, Cash ISAs, Lifetime ISAs (which have a maximum annual tax year allowance of £4,000 which counts towards your annual ISA allowance) – and Stocks and Shares ISAs.
Disadvantages for the borrower
- You may have to pay additional fees on top of the interest rate charged for the loan.
- You may have to pay a higher interest rate than that charged by traditional lenders if you have a poor credit rating. You may not even get a peer-to-peer loan if your financial profile is very poor.
- If you run into difficulties in repaying the loan, you may not receive the same protection as you would when borrowing through a traditional lender. A P2P website may, for example, pass on the bad debt to a debt collection agency, which could ultimately take you to court.
Disadvantages for the lender
- Loans, or investments, you make are not covered by the Financial Services Compensation Scheme. So if a borrower is unable to repay their loan, you may lose your money.
- If you want to get your money back during a loan agreement, you are likely to have to find another lender to take on the loan. The platform can normally arrange this for you, but the process may not always be as quick as you might like. There may also be a fee.
- Returns may be lower than expected if the borrower repays a P2P loan early.
Alternatives to peer-to-peer lending
If you’re a borrower, you could try a traditional lender, such as a bank or building society, an online lender, or a credit union.
If you’re finding it hard to be accepted for a loan, you could ask a friend or relative to act as a guarantor. This can make lenders more willing to accept your application as the guarantor will be responsible for repaying the loan if you’re unable to do so.
Alternatively, you could ask a friend or family member if they are able to lend you some money. Make sure both parties agree on how and when the money will be repaid if you choose this option.
There are alternatives to peer-to-peer platforms that investors could consider too, such as savings accounts, stocks and shares based investments, and government or corporate bonds.
Make sure you weigh up the risks before investing your money and seek professional advice if you’re unsure.
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.
Image source: Getty Images
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