Peer-to-peer lending: The ultimate guide

Last updated: 20 September 2018

Peer-to-peer lending (or P2P) is a brilliantly flexible way of making a higher return on your money than you get in the bank – without having to do heaps of research or learn a whole new vocabulary, like you do with property or shares.

I've had a small amount of money in peer-to-peer lending since its earliest days, and now keep a fair bit of my semi-liquid cash there. In this article I'll tell you probably more than you really need to know: it's not a bad idea to read through to understand the sector and the risks involved, but if you prefer you can skip straight to how I invest and which platforms I have money with right now.

As well as putting my money with several peer-to-peer platforms, I co-own a direct lender (which is very similar to peer-to-peer) called LendSwift which lends to property investors and developers. You can find out more about LendSwift here.

What is peer-to-peer lending?

In its simplest form, peer-to-peer is just lending money to another person (or business) without a bank getting involved in the middle.

It's clear to see why this is attractive. Normally you put your money in the bank, the bank gives you about 0.5% per year if you're lucky, then they lend it out for much more. Without the bank taking a big slice in the middle, you get a higher rate of return.

You still need someone in the middle bringing both sides together and facilitating the process, and that's where peer-to-peer platforms step in. The first in the UK was Zopa, which has been operating since 2006 – and over the last few years, tens of new platforms have come into the market. Each platform offers something slightly different, which we'll come to later.

At first, lending money directly to another individual might sound risky: what happens if they don't pay you back? In practice though, you'll spread your money across lots of different borrowers – so even if one doesn't repay, you'll only lose a small amount.

Why bother with peer-to-peer?

The attraction of P2P is that it scores highly on three different measures: safety, liquidity, and interest rate.

Let's take the basic case of leaving your money in the bank. It's safe (in theory) and liquid (you can access it any time), but the rate of interest is either low or non-existent.

Alternatively, you could invest it in a property. It's still relatively safe (properties tend to hold their value over the long term), you can get a high return if you buy well, but it's illiquid: if you want your money back, it takes time to sell the property.

P2P scores well on all three: it's relatively safe and relatively liquid, while still attracting a relatively high rate of interest. If you split your money across multiple borrowers you have negligible risk of major loss, you can quickly sell loans (under usual market conditions) to get your money back, and the interest rate is a lot better than you'd get in the bank.

What interest rate can you get? At the moment, I've got money invested in P2P platforms earning anything from 3% up to 12%. The main difference depends on what the platform uses the funds for – which we'll come to later.

As a result, I think of peer-to-peer lending as a cash alternative – while bearing in mind, of course, that it is at substantially more risk.

As a property investor you could decide, for example, to keep your savings in P2P instead of the bank while saving up for your next purchase – or you could keep your emergency fund there. Or, as a business owner, if you put money aside to pay your end-of-year tax bill you could keep that in peer-to-peer until you need to pay it over.

Again, it's not guaranteed to be risk-free or liquid, but you might decide that it's worth taking a bit more risk to get a bit more of a return.

Shall I say it one more time? There are risks to peer-to-peer. Later in this article I'll talk about how to keep this risk to a minimum, but it will always be there to some extent.

Is it a lot of work?

Getting a higher return than you would in the bank is all well and good, but there's not a lot of point if you have to dedicate all your spare time to assessing different lending opportunities, re-investing cash when loans end, and so on.

So, do you have to be that hands-on? Well, you can be – there are some internet message boards where people discuss individual loans in unbelievable detail, and seem to spend all their time finessing their peer-to-peer portfolio.

But you don't have to. Some platforms let you pick individual loans, whereas others hide all that away: you put money into the platform, then they spread it across different loans behind the scenes. There are also platforms that give you a choice: you can either pick individual loans, or automatically invest a certain amount into every new loan that comes up until you reach your limit.

In other words, it's as much work as you want it to be: everything from “I get to live out my fantasy career as a fund manager” to “My eyes have glazed over already – just show me the interest”.

Once we've covered a bit more background on the peer-to-peer landscape, I'll show you how to invest in a way that suits the amount of time/brainpower you want to dedicate to it.

Different types of peer-to-peer lending

There are three main “flavours” of peer-to-peer lending:

Some platforms will offer all three types of lending, while others focus on just one. You don't need to know about this in masses of detail, but it's helpful to get a sense of how your money could be used – and what the risks of each type are.

Consumer lending

Consumer lending is how peer-to-peer started: lending money to another individual for what could be any reason. In the earliest days of Zoopla, borrowers could actually say what they wanted the money for and you could choose which projects were “worthy” of your cash – whether it was for a new kitchen, a holiday, or to cover a gap in employment.

The reasons are now mostly hidden away and the platforms decide who to lend to, but consumer lending is still effectively the same thing. The important thing is that these loans are unsecured: there's nothing (like a house) held as security, so if the borrower defaults there's little chance of recovering any of the money.

Business lending

Lending to businesses can be to fund expansion, inventory, or to help cashflow during a difficult period. Business lending can be secured against property, but at the very least it will usually be personally guaranteed by the directors (who tend to have assets) and secured against the assets of the business (like equipment and stock) too.

Property lending

Lending against property generally isn't for people buying houses to live in, nor for investors who want a long-term mortgage. Instead, it tends to be for short-term refurbishment or development projects.

Property lending has risks too, of course, because there's always the chance of a project going wrong: a development running into trouble, a “flip” project being unable to find a buyer, and so on. But the benefit is that the loan is secured against the property – so if the borrower defaults, the property can be sold to recover at least some (usually all) of the money owed.

What are the risks of peer-to-peer lending?

As I said earlier, there's risk in peer-to-peer as there is in any investment. The important thing is to understand where the risk lies – which we'll do in this section – and after that, we'll run through the actions you can take to keep this risk as low as possible.

Loans going bad

The most obvious risk is the borrower being unable or unwilling to pay you back. It can happen with any type of loan, but the risk is more pronounced when the loan is unsecured because there's nothing you can seize to get at least some of your money back.

By its nature, peer-to-peer suits borrowers who are unable to get funding from banks at lower rates because they're a higher risk – so however much you trust the platform's underwriting, it's rational to assume that some proportions of your loans will go wrong at some point.

Platforms collapsing

A less visible risk is the actual lending platform getting into trouble. The majority of peer-to-peer platforms in the UK are currently operating at a loss: they have backers who are expecting to absorb these losses for a number of years, but it's entirely possible that a platform could go out of business. Indeed, one UK-based platform was closed down by the FCA in 2018 and investors are still (at the time of writing) waiting to see what happens.

Any decent platform will have arrangements in place for if something goes wrong, and in theory someone else will step in to ensure that all loans are wound down in an orderly way. However, in practice that can be a messy process and you can't guarantee how long it will take to get your money back – if you do get it all back.

Unable to access funds

I said earlier that the advantage of peer-to-peer was that your funds are relatively liquid under usual conditions. This is because many platforms have the facility to sell your loan agreements to other investors – something often called a “secondary market” – and usually, there will be plenty of investors standing by willing to buy what you're selling.

However, like all markets, peer-to-peer is all about confidence. If there's a general loss of confidence in the economy or a specific loss of confidence in a particular platform, everyone could want their money back all at the same time – just like a run on a bank. If that happens, there could be lots of loans being sold and none being bought – meaning that you can't get your cash out.

The underlying loans should still continue to perform, but it's important to be aware that the liquidity aspect might not hold under all conditions. (To be fair though, you could say exactly the same thing for banks.)

How to stay safe with peer-to-peer

If you're still reading after hearing all the risks I've just run through, you're clearly made of reasonably stern stuff – and peer-to-peer investing might be for you.

I hope that is the case, because while it's important to understand the risks I don't mean to overplay them – especially as there's a lot you can do to control that risk if you invest your money intelligently. Here's how…

1: Pick the right platforms

Personally, I see “platform risk” as the biggest danger of peer-to-peer: some loans are always going to go bad, but you don't want to deal with a whole platform running into trouble.

Even if a platform doesn't get into difficulty, there's still the risk that their loan selection will suffer: they might start saying “yes” to loans where they should say “no”, either because of inadequate staffing or the desire to grow.

(As I said earlier, on some platforms you can pick your own loans – but I still want to assume that every loan offered is basically fine to invest in, without having to do endless due diligence myself.)

So, what makes a good platform?

A good track record

The longer the platform has been successfully running for, the better. Most will also display statistics about their historic defaults (including how much capital was recovered) and their expected loss rate.

Good liquidity

Liquidity (under normal market conditions) is one of the big advantages of peer-to-peer.

One source of liquidity is an active secondary market. As I said, a “secondary market” allows you to sell your loans to other investors: in other words, you could lend to someone for a fixed term of 12 months but then sell your share of that loan to another investor two months later to get your money back.

At the moment, pretty much all platforms have higher investor demand than borrower demand, so lots of people will snap up anything that becomes available – but that won't necessarily always be the case.

Some platforms work differently, and hide the secondary market away – basically just giving you a “withdraw” option, and sorting out all the buying and selling behind the scenes.

Either is fine: I just want to know that I can have a reasonable expectation of getting my money out if I need it.

Good user and customer experience

If the website is a pain to use and you can't get help when you need it, it's not a good sign for how the operation runs as a whole – as well as just being annoying.

2: Diversify between loans

The golden rule of peer-to-peer is “eggs and baskets”.

The more loans you can spread your money between, the less affected you'll be by any one default. For example, if you split a £10,000 investment between 1,000 different loans, if one loan goes wrong you'll only lose £10 – which should be more than offset by the interest on the others.

As I said before, some platforms do this automatically – but if you're picking your own loans, you should split your funds between as many of them as you can.

3: Diversify between platforms

This just takes “eggs and baskets” one step further. If you've split your money between lots of loans and they're all on the same platform, you could still be massively affected by anything that happens to that platform.

The failure of a platform shouldn't be a disaster because the underlying loan contract is directly with the borrower, and the platform should have arrangements in place for someone else to step in and administer everything if needed. But still, if it happens you don't want to be stressing about it any more than necessary – so diversifying between loans and platforms is the safest approach.

My principles for peer-to-peer investing

My aim with peer-to-peer is to make an overall level of return that I'm happy with, while taking up pretty much no time. What I am for is:

To achieve that outcome, I've come up with four “principles” for what I invest in:

  1. Pick platforms, not loans
  2. Lend across a handful of platforms
  3. Favour asset-backed lending
  4. Look for an easy exit

This isn't going to be the right approach for everyone: for example, if your aim is to maximise your return regardless of time or risk you'll need to make different decisions

But in case your aims are similar, here's how those four principles help me to achieve my “decent hands-off returns” objective.

1: Pick platforms, not loans

Frankly, I have no desire to look into the likelihood of a particular piece of land getting planning permission, or scrutinise the balance sheet of a certain company to see if they can afford a loan.

Even if I enjoyed it, I'd get a far higher return on my time elsewhere: when it comes to my investments, I just want to set them up sensibly then let them run.

So, my approach is to only invest on platforms where either:

2: Lend across a handful of platforms

If you wanted maximum diversification, you'd split your funds across every platform that exists – but beyond a certain point, the time and hassle involved just gets ridiculous.

So my personal rule is that I'll invest across a maximum of five platforms. At the moment, I'm on four (plus the one I own).

You might choose a different number, but I find that this gives me confidence that I've got enough of a split without having to spend much time logging into different accounts to see what's going on.

3: Favour asset-backed lending

I have a strong preference for participating in loans backed by property: as long as the loan-to-value is sensible and the valuation is accurate, there's an extremely high chance that all the capital will be recovered even if the borrower defaults.

I'm fine with asset-backed business lending too – secured against business property, inventory, or other tangible assets.

I'm a little more wary about unsecured consumer lending, because there's very little recourse if they stop paying – although the loan sizes are smaller than to businesses, which helps because you can get more diversification with the same amount of money. I'll get involved with some consumer lending in the interests of diversification, but three of the four platforms I currently invest through don't lend to consumers at all.

4: Look for an easy exit

I like platforms where you can basically hit “withdraw” and they do the rest – re-allocating your loan parts behind the scenes, meaning you get your money quickly and with no hassle as long as there are other investors waiting to step in.

Three of the platforms I currently invest in offer this. The other has a secondary market that's easy to use and active enough that I've always been able to sell quickly in the past.

The platforms I invest in right now

Just to illustrate how those four principles boil down to action, this is a list of the platforms I invest with at the moment. I'll do my best to keep it updated as things change.

Please bear in mind that these are just the platforms that I've chosen to achieve my particular goals. They may or may not suit you, and they're not recommendations: I have no special knowledge of how they operate, and there may be better options out there that I don't know about.

Also, just because a platform isn't on this list doesn't mean I don't like it. I've dabbled with plenty of good ones, and I've got others on my list to play with: I'm just keeping it simple at the moment due to a lack of time.

So this is just what's working for me right now, and I'll keep this section updated as things change. (Last updated: July 2018.)

[Highlight]The links below may be affiliate links, which pay me a commission when you sign up – often, they pay you a bonus too. I say “may be” because I keep this section updated to reflect who I invest with, not who pays a commission.[/Highlight]

Assetz Capital

Assetz has a variety of different products – including one where you can actually pick individual loans you want to invest in. They lend only to British businesses, either secured against property or some other asset.

I use the Quick Access Account, which targets an interest rate (at the time of writing) of 3.75%pa, which is paid monthly. As the name suggests, there's no lock-in – so under normal conditions, you can withdraw your money immediately.

The interest rate isn't great, but I like the fact that it functions just like a normal bank account: you can just park your money there and make a decent rate of interest, without having to know anything about what's going on behind the scenes. It also provides a good amount of diversification between loans.

Check out Assetz Capital here

Ratesetter

Ratesetter is very similar to Assetz in terms of how it functions: stick your money in, magic happens that you're unaware of, and you get a decent return. The difference is that Ratesetter lends to individual consumers and property developers as well as businesses.

The instant access account pays (at the moment) 3%pa, and you get paid your interest in one lump when you withdraw rather than monthly. Alternatively, you can lock your money up for five years and get a rate of 5.4%pa, paid monthly.

Again, this is just a dead easy place to stash cash and earn interest without having to think about the mechanics too much.

Sign up to Ratesetter via this link and earn a £100 bonus

(Find out more about how the bonus works)

BondMason

BondMason is my favourite platform, because it's actually more like an aggregator or fund than a lender.

BondMason has relationships with a large number of peer-to-peer platforms and direct lenders, and takes a stake in loans that those platforms offer. When you put your money into BondMason, it then splits it across 100 of those loans.

In effect, this gives you platform diversification and loan diversification all in one – although of course something could still happen to BondMason itself. It also means that the loan has had a second level of due diligence: once by the platform who originated the loan, and once by BondMason.

BondMason targets an annual return of 8%, from which they deduct a fee of 1.5% – giving you a net annual return of 6.5%.

The only drawback I've spotted so far is that it can take a while for your cash to be loaned out, which puts a drag on returns. Still, I'm currently earning over 8% even with this “cash drag”.

Sign up for BondMason here

Lendy

This is very different from the other platforms I use, because you actually pick individual loans to invest in. The interest rate offered on loans is between 8% and 12%.

If you trust the platform and you're willing to invest in every loan, it's not that much extra effort to invest because you can “auto-bid” and commit a certain amount to every loan that launches. You can also choose (if you want) to only transfer the funds once your participation has been confirmed, so you don't have cash sitting around waiting to be used.

It does though make it a bit more effort to access your cash, because you need to individually sell each loan on the secondary market and wait until there's a buyer.

Lendy needs to be approached with a bit of care. The loans they make are at the risky end of the spectrum: land without planning permission, the early stages of huge development projects, and so on. Loans routinely run beyond their agreed term, and they've suffered a loss of capital on at least one loan. Many investors aren't happy with them, and I don't like that they structure loans to make all their money at the start so they're more incentivised to make new loans than effectively monitor existing ones.

Because the interest rate is high I'm willing to take a punt and I can live with some losses, but this might not be for you if you want a completely smooth and easy ride.

Sign up for Lendy via this link and receive a £50 bonus

LendSwift

This is a platform that I co-own and where I sit on the credit committee, so I put my money where my mouth is by investing significantly more than I do with any other platform.

We lend to property investors for refurbishments, flips and small development projects. Uniquely, me or my co-director (or both) put our own money into every loan in a “first loss” position – meaning that if anything went wrong, we'd lose money before anyone else did. Perhaps in large part because of the caution this brings to our underwriting and the close eye we keep on loans once we've made them, we have an exceptionally strong track record so far.

We're largely self-financed with a couple of institutional partners, but we do sometimes open up to funding from investors who meet the FCA definitions of “High Net Worth” or “Sophisticated”.

You can find out more about investing with LendSwift here

Conclusion

I've gone heavy on the dangers just so you're well aware that it's not risk-free, but I really am a huge fan of peer-to-peer.

The great thing is that it can work for everyone, because there's so much choice: you can either use it as an alternative to a savings account with a higher rate of interest (as I mainly do), or get really involved and have complete control over how your money gets used.

And it cuts banks out of the loop. What's not to like?

If you're looking for “alternative” investments, I think peer-to-peer is a great start: it's very little effort, and you don't need to develop any knowledge before giving it a go. Just put a bit of money in, check your balance each month, and chuckle evilly while rubbing your hands together.