Money Week | David C Stevenson | May 30, 2016

Yet as the banks have cut rates available, other providers have stepped in, hoping to tempt investors and savers with more attractive potential returns.

Alternative finance is one such niche area that has emerged from nowhere in the last eight years, with pioneer company Zopa leading the way in providing what are called “P2P (peer-to-peer) lending accounts”.

So what are these, how do they work, and should you consider using them?

What P2P can offer adventurous investors

The idea behind Zopa and its big rivals Ratesetter and Funding Circle is very simple. Why have a bank act as an intermediary between savers and borrowers?

Go direct. If you’re an investor, then why not lend your money directly to a lender through a marketplace – the financial equivalent of eBay.

See:  UK Alternative Finance Grows by 84% to £3.2 Billion in 2015

Back when these P2P sites first launched, the idea was truly radical. You set the term (number of years) you’d want to lend over, and the interest rate you required. Then you’d wait for borrowers to accept your terms. The market in effect “set the rate” (that’s the idea behind Ratesetter as a brand).

Times have changed, of course, and now the big two platforms lending to consumers (Zopa and Ratesetter) operate much more like an online fund.

You lend your money into a pot. That pot of money is in turn lent out to borrowers, mostly prime or just below prime borrowers (the most creditworthy). The interest rate you receive depends on how long you want to lend for – and what protection you want in case of lenders defaulting on their payments to you.

The tables below explain the current investment rates on offer for lending on Zopa and Ratesetter.

Ratesetter

Protection Fund size (see below for more on this): £17.7m, coverage ratio against expected defaults 133%

Total money lent: £1.11bn

Zopa

Protection Fund size: £12.24m

Total money lent: £1.39bn

Both of these reasonably well-known brands now offer real choice for income-orientated investors – even more so when you consider that both are about to launch Innovative Finance Individual Savings Account (Isa) wrappers.

At a time when the average high streets savings account pays well under 2% a year, the rates above represent a real boost for income seekers. And both of these brands have been working incredibly hard to reassure investors that their money is safe.

See:  Open Letter: lifting the veil on P2P in Canada

Boiling it down, there are four big selling points to using a P2P lender:

1. You have a choice of products and terms over which you can lend your money. If you are ultra-cautious, you can lend for just one month or a year. The choice of risk is yours.
2. The biggest underlying risk is that the borrowers don’t pay back their debts. Defaults are however, currently running at very low levels for both Zopa and Ratesetter, as both platforms have a good record of making personal loans to consumers (although Ratesetter in particular is diversifying and now lends substantial amounts to businesses as well).

Most historic data suggests that even in a recession, consumer default defaults remain well below 10% and most of the time stick below 5%. Current default levels are around 1% or less.

3. Both platforms offer protection funds where a levy on transactions is used to build up a fund, which should be able to compensate investors for losses. The tables above contain details of these funds. Both platforms reckon that even if defaults doubled, they’d still have enough money in reserve to pay for any losses. If defaults went up five fold, there may be some loss of interest.
4. Each platform has also developed fairly detailed plans to make sure that if they – the online marketplaces – go bust, you’ll still have your loans in your name. In this extreme example, an appointed specialist will wind down the loan book, collect your interest and make sure your loan is repaid.

Continue to the full article --> here