Peer to peer

The pros and cons of P2P lending




Peer-to-peer platforms have revolutionised lending, allowing retail investors to benefit from what was once the preserve of financial institutions and high-net-worth investors.

Retail investors can enjoy fixed interest rates and fixed investment terms – often with a duration of just a few months.

How does peer-to-peer work?

Most peer-to-peer secured lending is focused on providing bridging loans and/or development finance. Investments typically last between six and 18 months.

By acting as an intermediary between borrowers and investors and cutting out institutional lenders, peer-to-peer secured lending can enable retail investors to earn high rates of interest – often 7-10% pa. 

Property-backed investment is also protected by the underlying value of the borrower’s property. If the borrower defaults, the holder of the legal charge can take possession of the property and start to recover investors’ money.

Typical borrowers are property developers looking to refurbish and flip a property, or business owners who need cash quickly. Money is secured against the borrower’s property by the registration of a legal charge in the same way a bank secures a mortgage loan.

What are the pros and cons?

Pros

1.    Potential returns are excellent, and much higher than can be achieved with dividend yields.
2.    Returns are fixed, and don’t fluctuate like returns from equity investments or the stock market. 
3.    Lenders are not charged fees, so the amount stated is the net amount investors receive.
4.    Platforms no longer have to deduct tax at source, so investors will be paid gross and account for their own tax. 
5.    Investment terms are typically under 12 months.
6.    Legal charge holders will be paid out as a priority before any owners/equity shareholders.
7.    It is FCA regulated, so platforms must be transparent and are legally obliged to be upfront about risks. Platforms must have contingency plans in place, such as a significant financial buffer. 
8.    The launch of the Innovative Finance Isa means peer-to-peer loans can be held within an Isa, so returns are tax free. 

Cons

1.    While regulated by the FCA, peer-to-peer lending is not covered by the Financial Services Compensation Scheme, so losses are not underwritten by the government. 
2.    Peer-to-peer loans are likely to be tied-in until the borrower has repaid, unless the platform can find a buyer. 
3.    Loan periods are short, but investors may have to wait for the loan to complete before they start earning interest. One alternative is for investors to lend money to the finance company and get a fixed return for a fixed period. The rate will be less, but interest will be continuous, so investors can end up with approximately the same return, without having to select individual loans to invest in.
4.    If the borrower does not repay on time, investors need to wait until they have repaid – although they should continue to earn interest in the meantime.
5.    If the borrower defaults, the property will have to be repossessed. If that’s the case, there could be delays of at least several months. The property may not achieve a sale price that allows lenders to be repaid all their capital and/or the interest owed. 
6.    While investors will receive a fixed rate of interest that may be higher than average dividends, they will not benefit from capital growth.

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