What is a peer-to-peer loan?
A peer-to-peer loan matches up individuals that are willing to lend to other individuals who are looking to borrow. By cutting out the middleman, peer-to- peer lenders do not have the same overheads as traditional banks which is why they can pass on these savings to the consumer and offer much more favorable rates. Borrowers get better rates than other types of loans and savers get better rates than if they used a savings account from their local bank.
Peer to peer lending is a very innovative approach to modern lending in the UK and is becoming very popular with over £600 million being lent out by individuals since 2005. There are no peer-to-peer loan companies trading on the high street so the lenders operate more like an online marketplace. They are also known as ‘money-cupids’ or ‘matchmakers’ pairing up people who want to earn a return on their money, with those who want to borrow it and at a rate they both agree on. The loan company simply takes a fee for making the introduction and managing the process and this is included in the price.
Using our comparison table above, you can compare peer-to-peer loans allowing you to borrow up to £25,000. The cost of the loan is presented in APR (annual percentage rate) and this is the standard measure of all financial products. The Representative APR is the rate given to at least 51% of all successful customers and it will vary on the amount and duration of your loan. The payment example we provide for each lender gives you an idea of how much you are expected to repay in monthly instalments and should give you a better idea of how the loan works.
Credit ratings play a big role in peer-to-peer lending. Everyone has a credit score that reflects how well they have paid other loans and credit in the past such as credit cards, car loans and personal loans. Credit scores can be broken down into five categories; very poor (0 – 560), poor (561 – 720), fair (721 – 880), good (881 – 960) and excellent (961 – 999). If you have not made your previous payments on time, you will likely have a low credit score but if you have repaid your bills on time, you will have a high credit score.
With peer-to-peer lending, how good your credit score is will be factored into how much you can borrow and what interest rate you will pay. Borrowers with good credit will pay low amounts of interest and customers with bad credit will pay higher amounts of interest because there is a greater risk of default. The lenders can choose whether to lend to those with good or bad credit so if they decide to take on more risk and lend to those with bad credit, they will receive a far greater return than lending to those with good credit.
Peer to peer borrowing is popular for individuals to pay for home improvements, emergency expenses or big purchases such as a car or wedding. Small businesses, mostly sole traders, use peer-to-peer loans for the flexible terms and easy access to finance. Borrowing from a peer-to-peer loan company is completely unsecured and you are not required to put down anything as collateral. It is different to every other type of loan because you are borrowing from an individual or group of individuals using a company like Zopa as an online marketplace.
The longer the loan, the cheaper it is
People like borrowing from a peer-to-peer lender because there are very favourable rates. This type of loan has great flexibility as you can usually choose the repayment terms over 1, 2, 3, 4 or 5 years and the longer the loan, the lower the interest rate you will repay. There are also no early repayment fees to close the account early.
Bad credit scores accepted
The lender will always run credit checks and even if you have bad credit, you are still eligible for a loan but will pay a higher interest rate than those with good credit. For those with good credit, there is the benefit of a paying a lower rate than they would elsewhere.
Peer to peer saving
People are attracted to saving with a peer-to-peer lender because the rates of up to 6% are far better than the savings accounts from a standard bank. The average amount to lend out is around £2,000 but you can start investing as little as £10 with no maximum. The peer-to-peer lender will spread your money across a mixed basket of individual borrowers and small businesses and take an annual servicing fee of around 1%, which is included in the price. The rate of interest you have been quoted is subject to change based on the bad debt of this group of individuals. By spreading the money out, it intends to minimize your risk and maintain the interest rate you have been quoted.
Using peer-to-peer lending as a savings account doesn’t mean that you will have to chase up the individuals who didn’t repay the money you lent out. Each peer-to-peer lender has collection teams dedicated to recovering bad debt so you don’t have to.
Lend to high-risk candidates for a higher interest rate
How much interest you can earn on your investment depends largely on your risk appetite because you choose which pool of individuals you would like to lend to based on the credit ratings of Excellent, Average and Poor. If you are willing to lend to those with poor credit, you will receive a higher return of interest (sometimes double) compared to a lower rate for those customers with excellent credit rating. The idea is that lending to customers with very good credit does not pose much risk to the lender because they have previously demonstrated their ability to repay loans and other forms of credit on time. By comparison, lending to those individuals with poor credit has a greater risk of bad debt and they will likely be charged more as a result. If your pool of customers with poor credit repays successfully, you will deservedly receive a greater return.
Keep your money fixed for longer for greater returns
How long you keep your money fixed for will reflect on the interest rate you receive. When you decide to lend with a peer to peer loan company, you will have the choice to lend your money at a fixed interest rate of 1,3 or 5 years and the longer you keep your money with that company, the more commitment you are showing and the greater the return.
The pool of customers you lend to will make payments every month and you are able to withdraw this money every month as income but you must pay tax on it. If you decide to keep lending the money out, you will reap the returns of compounded interest meaning that your interest will make interest and lead to a greater return. You will always be able to withdraw your money early if you need it for an emergency but it may take a few days to process and you may receive a reduced rate.