What is Peer-to-Peer (‘P2P’) Lending?
P2P lending is when investors are connected directly with borrowers via a P2P investment platform. The P2P platform pools investors funds and releases these funds to borrowers at varying interest rates based on risk metrics. Borrowers typically benefit from this arrangement as P2P platforms may be able to provide quicker access to finance, or may be able to secure better rates than those offered by high street banks.
It is important to note that the individuals/businesses who borrow from P2P platforms do undergo credit checks and are assessed to be credit-worthy by the platforms. Whilst some platforms enable investors to perform their own due diligence, investors frequently rely on the due diligence performed by P2P platforms internal credit control teams.
How does P2P lending differ to property crowdfunding?
Whereas P2P platforms enable investors to invest in debt instruments, crowdfunding enables investors to take an equity stake (i.e. investors own a proportion of the property they are investing in).
How do the various P2P platforms differ?
The key differentiating factors between platforms are as follows:
- Loan term (specifically, how long your funds are tied in)
- Secured vs. unsecured (i.e. are loans asset-backed)
- If secured, type of security (i.e. property, business assets, personal goods)
- Existence of a loan loss provision (and the level of cover it provides vs. expected bad debt)
- Existence of a secondary market (and whether there are fees associated to resell)
- Manual vs. automatic investing (i.e. extent to which a platform enables hands-free investing)
What risk is involved when investing in P2P lending platforms?
The key thing to understand is that investments made via P2P platforms are not akin to investments made via UK savings accounts. When you place savings in a UK high street bank or building society, your funds are covered by the FSCS which guarantees your individual savings up to £85,000 should the bank or building society go out of business.
However, no such safety net exists with regards to P2P investments. By investing your funds in P2P lending, you must accept that the potential for higher returns vs. bank savings comes with the price of increased risk.
Are the P2P firms regulated?
The P2P industry has been regulated by the Financial Conduct Authority (FCA) since April 2014. All platforms reviewed on this website are fully authorised by the FCA.
The FCA sets clear rules aimed to protect investors interests. For instance;
- Client money must be held in segregated client money accounts, which are protected in the event the P2P business itself goes out of business. Note: this only applies to money held in your account which is not being utilised (i.e. not loaned to borrowers).
- Resolution plans must be in place, meaning firms must have contingency plans to ensure that loan books are managed to maturity in the event of platform failure.
The alternative finance sector is constantly evolving and the FCA will undoubtedly evolve its own policies in response over the coming years.
What are the tax implications of investing in P2P lending schemes?
Unless you have invested via an Innovative Finance ISA, interest earned through P2P platforms is subject to UK Income Tax.
Interest generated via P2P platforms are akin to savings interest in the eyes of HMRC.
In the 2018/19 tax year:
- Basic rate (20.0%) tax payers are able to earn £1,000 interest per year with no tax.
- Higher rate (40.0%) tax payers are able to earn £500 interest per year with no tax.
- Additional rate (45.0%) tax payers do not get an allowance.
If you go over your allowance, any interest you earn will be taxed at your marginal tax rate (i.e. the highest rate of tax you pay).
The applicable guidance on savings interest can be found here (link). Peer to peer lending interest is specifically cited.
Tax relief can be claimed where a peer to peer loan is not repaid by the lender. This loss can be offset against any other interest income generated from P2P lending before this income is taxed. Further specific guidance regarding peer to peer lending can be found here (link).
Please note that tax rules frequently change. The above summary is based on my interpretation of the HMRC guidance published online. Please do your own research with regards to the tax implications of any investments you make via P2P platforms. My summary does not constitute tax advice or guidance.
What is an Innovative Finance ISA (‘IFISA’)?
- Introduced in April 2016, the Innovative Finance ISA has proven a popular method of investing funds in P2P platforms. Interest income generated from funds invested in IFISA’s is not subject to UK Income tax.
- Only firms authorised by the FCA are able to offer IFISA’s to their customers.
Can I open an Innovative Finance ISA alongside other cash or stocks and shares ISA’s?
Yes. The Innovative Finance ISA is considered a separate type of ISA to a cash ISA or a stocks and shares ISA. You can currently open one of each in each tax year provided you don’t go over the overall ISA subscription limit.
Do P2P platforms offer guaranteed returns?
No, just as you would not consider stock market returns to be guaranteed, returns from P2P investments can equally never be considered guaranteed. All capital should be considered at risk.
Some platforms do offer a headline ‘fixed’ return but it cannot ever be considered truly guaranteed because there may be complications caused by bad debt or platform issues.
Is investing in P2P riskier than making equity investments?
It’s not quite as simple as that – just as there are many different shares which you can invest in, there are also many different P2P platforms. Read our article on peer to peer lending vs equity crowdfunding investments to understand the key differences between the two forms of investment.
What is a provision fund?
Read our article on provision funds and ‘skin in the game’.
What is ‘skin in the game’?
Read our article on provision funds and ‘skin in the game’.
Why do P2P websites offer cashback for sign-up?
P2P platforms offer cashback incentives in exchange for the investment of funds because their profitability is directly linked to the total value of loans under management. If a platform can convince you to become a customer and they deliver strong returns, you are likely to remain a customer and may invest further funds. This is no different to high-street banks offering ‘switch bonuses’ to entice you to become a customer. Banks do this as they hope you will take out other revenue-generating products such as mortgages, personal loans or credit cards.