Can you trust ‘peer to peer’ lending?
Last week saw the return of Bank of Dave on Channel 4. The television show, which proved to be a surprise hit last summer, chronicles one man s attempt to take on the might of the banking establishment by opening a viable alternative in his home town.
Despite widespread support, which saw local residents queuing to hand over their money so he could lend it out to Burnley-based businesses, the second series focuses on the problems Dave Fishwick encountered trying to get this project off the ground.
Not surprisingly, his antics have struck a chord with many, fed up with the poor service, miserly savings rates and draconian lending rules deployed by the main high street banks.
But while most wouldn t want to go as far as the people s banker and set up their own bank, there are already established ways that consumers can bypass the banks when saving and borrowing.
So-called peer-to-peer lenders, which link those with cash to spare with those wanting to borrow money, have now been in operation in Britain for almost 10 years. This year the lenders operating in this market are expected to arrange some £500m of lending business.
The names of the biggest peer-to-peer lenders Zopa, Ratesetter and Funding Circle are hardly household names, and certainly far less familiar than the likes of Barclays, HSBC or NatWest. But recently the Bank of England has suggested that these new kids on the block could become a major force in the financial market over the next decade.
Some offer loans to individuals, some use the money raised to lend to small businesses. Although each works in a slightly different way (see below), the basic premise is the same. The lender acts as an introducer, and takes a fee for this service. But in most cases the fee is significantly less than the margin charged by banks, as peer-to-peer lenders do not have to guarantee savers deposits nor take on the risk that borrowers be they home owners, credit card customers or small businesses will not pay back their loans.
If they do default, it is the savers who will lose, not the peer-to-peer lender sat in the middle.
This gives them their greatest advantage over the banks, as well as their biggest pitfall.
Lower operating costs mean that the peer-to-peer lenders can offer cheaper loans and pay higher interest rates to savers, which has proved particularly attractive in the current climate.
But savers should not forget the maxim that higher returns mean higher risks. At a time when the economy remains tough and unemployment remains high, there is a danger that the number of defaults could rise, putting savers money at risk.
None of these schemes is covered by the Financial Services Compensation Scheme so savers have no recourse for compensation if they lose their money.
However, the various peer-to-peer lenders use a number of ways to reduce the risk of an individual saver losing all their money. They will also argue that stringent credit checks on borrowers mean that to date their default rates are lower than most high street banks.
Alternatively, if this all sounds too risky, there are always traditional credit unions to consider. These are often run by work-based unions, or are based in a particular town, and again aim to provide small loans to those in need, funded through a savings book.
Although savers will have more protection than through a peer-to-peer lender, typically the rates offered to savers are far less competitive, and not any better than most would be able to get from a best buy savings account.
However, they will often advance credit to those who are unable to get a personal loan from a high street bank, and their terms will be far more favourable than unauthorised overdrafts or payday loans, which can often be the next resort of those struggling financially.
Below we look in more detail at the main peer-to-peer lenders and highlight what rates they pay, what the current default rates are and what steps they take to help protect savers money.
Launched March 2005
Amount lent to date: More than £278m
Default rate 0.5pc
Average savings rate 5.4pc (after charges and defaults)
Average loan rate 6.7pc (on £5,000 loan)
Fee paid by savers 1pc of the amount lent
Fee paid by borrowers Up to £190 per loan, included in advertised APR
Zopa was the first peer-to-peer lender to launch in Britain and remains the largest. One of the keys to its success has been the low default rate, achieved through strict screening of potential borrowers: it said more than 75pc of borrowers who apply for credit are turned away. Those that are successful typically get loans that are 20pc cheaper than those offered by the high street banks.
If you want to borrow money, not only will your credit file be checked, but also affordability factors. A spokesman said: Many people may have a good credit score because they haven t defaulted on loans in the past. But if they are taking on debt which they could struggle to repay in future, we will turn them away because they pose too big a risk.
Savers who are putting up this cash should also know that their money is split across a minimum of 50 borrowers, so they don t have more than £10 with any one borrower. They can also choose which type of borrower they want to lend to, and how long the loan is for. This will affect the return they receive.
In each category, a range of rates is displayed and the saver then sets the return they want to earn on their money. If they go lower than the suggested range, their money will be snapped up instantly; if they go higher, they may struggle to attract borrowers. They can, of course, diversify further by spreading their money between different lending groups.
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Launched October 2010
Amount lent to date: £58m
Default rate 0.35pc
Average savings rate 5pc (after all fees)
Average loan rate 7.6pc (on £5,000 loan)
Fee paid by savers 10pc of interest received (all interest rates shown after fees)
Fee paid by borrowers From £80, depend on term and size of loan
With Ratesetter those putting up money don t have to choose who they want to lend money to. Rhydian Lewis, the founder of the site, said: We ve found many customers find it difficult to judge the relative merits of lending to an A* borrower at 5pc or an A borrower at 6pc. Instead savers are given one interest rate set by the market on the site on any given day. The only variable is how long your money is tied up for (the longer the period, the higher the rate). Ratesetter also offers short-term products, paying 2.5pc if customers lock funds away for just a month and a rate of 3.2pc on a one year bond.
The key difference is the provision fund to cover bad debts. This is paid for by the borrowers, via an additional rate charge, with higher-risk borrowers making a higher contribution to this fund. This fund isn t guaranteed to cover all defaults in full. But as it stands now at £838,000 bad debts would need to increase 11-fold before savers are affected. To date all saver have received back every penny lent, with interest paid in full.
Mr Lewis said: Our users enjoy the additional security of our provision fund. While we are making clear that this is not an absolute guarantee, it should provide additional peace of mind.
Our stringent credit checks mean that only about 10pc of loan applications get through at present. This ensure the default rates remain within the scope of the provision fund.
Launched August 2010
Amount lent to date £81m
Default rate 1.5pc
Average savings rate 5.7pc (after charges and defaults)
Average loan rate 8.8pc (on £5,000 loan)
Fee paid by savers 1pc annual fee
Fee paid by borrowers 2pc to 5pc depending on loan type
The twist here is that money is lent to small businesses, rather than individuals. James Meekings, the co founder, said they were aiming at low-risk businesses struggling to get finance from the banks at affordable rates.
All firms are screened and the company will not accept either start-ups or sole traders.
While firms are required to have a minimum of two years audited accounts, Mr Meekings said many will have far longer trading records, on average 15 years, and a significant proportion is lent to companies in manufacturing.
However, he stresses that lending money to businesses is not without risk and this is reflected in the returns paid. The maximum interest that can be earned is 15pc, though the average is nearer half this.
In many ways these are not comparable with the returns paid on savings accounts, where there is very little risk involved, he said.
Mr Meekings said a fairer comparison was the returns made from corporate bonds. Savers can access their money at any point, by selling their loans on to other lenders, but there is a 0.25pc charge for doing this.