What is peer-to-peer investment?
Peer to peer lending platforms are financial matchmakers. They match borrowers with potential lenders who are looking to get good returns. These firms eliminate the middleman, which is usually ‘bank.’ With peer to peer investment, you can put up money for lending and get higher interest rates than the traditional savings account. The investors get higher rates while the borrowers pay less interest compared to a traditional loan. The p2p lending firms profit by charging fees.
However, before you get too excited by the higher rates and invest all your money into peer to peer investment, it is important that you understand that it is not like conventional savings accounts. P2p lending might sound like saving. However, since there is no savings safety guarantee, and there is a risk that you may lose your money, it is actually an investment.
It is also important to know that the platforms don’t just hand out loans to everybody. The borrowers are handpicked through credit checks and are rated based on the risk they pose. The peer-to-peer platforms are responsible for doing all the repayment chasing on investors’ behalf, so there is no hassle for you. But, there are still risks involved that you must consider before you put your funds in.
The Financial Conduct Authority has launched new rules that are tighter for peer to peer lenders. Furthermore, the new investors cannot put more than 10% of their funds into peer to peer investment.
You MUST know the risks – peer-to-peer lending isn’t for everyone.
- Brexit’s impact on peer to peer industry
As of now, the economic situation is uncertain because of Brexit. Some people are of the option that it will be good while others disagree. However, what we know is that there is huge uncertainty. Peer to peer is a relatively new industry, the majority platforms have not ridden through a downturn, and we are not sure how they will.
Below, we are going to enlist other risks involved in peer to peer lending down below. The purpose of mentioning these risks is not to say that you shouldn’t invest in peer to peer, but it is to make you well informed so you can make the right decisions.
- There is a risk of not getting the money back.
While for most peer to peer lending platforms have worked well, the primary risk is not getting repaid if the borrowers you have lent the funds to don’t pay it back. Every peer to peer firm has their way of lessening the risk. So, you must ensure that you know what kind of provision the platform has in place before you choose it.
- It isn’t easy to get money out before the term ends.
Most peer to peer lenders allow investors to withdraw their funds early by matching their existing loans with new investors. While this may work, lenders may have to wait before they can find investors. Also, there is a question of how this market works if the rates were to increase. If yes, then when you lend out at 4% and want to exit early, the newcomers can lend out 9%. How simple would it be to get somebody to take over your loans at less interest rate?
- There is no guarantee of savings.
With the traditional UK savings, the Financial Services Compensation Scheme provides you a level of protection. It guarantees to pay back the first £85,000 of any funds saved per person, per financial institution if that institution goes bust. Any money you have invested into peer to peer lending does not get the FSCS protection, even though the lenders are regulated.
- Your money might not get lent away quickly, so you will not earn interest for a while
You earn no interest when your money is waiting to be lent. Depending on the platform, it can take a few days to match you with the right borrower. Specifically, keep in mind if you are investing a lot of money, since it may take longer to be lent out.
- The offered interest rate by lenders is NOT guaranteed.
The lenders always quote the ‘projected’ ‘expected’ or ‘target’ return to investors, but in reality is that you get may get a lower interest rate, for instance, if a part of your funds that you lent is not repaid, or if the borrower repays the loan early.
We have enlisted all the potential risk factors so you can make a well-informed decision and invest your money in the right place. Remember, to not just fall for the attractive interest rate, consider all other aspects before you choose a peer to peer platform. Besides investing in peer to peer loans, you can also invest in Innovative Finance ISA to make your money work harder for you.