As interest rates remain low, should you be tempted by Peer to Peer lending?New figures from the Financial Conduct Authority show that many beleaguered savers are struggling to find ‘real returns’. The research showed that a saver who opened an account five years ago, and has stuck with it ever since, is getting an average interest rate of 0.3%, well below the current rate of inflation.

Savers have many options for improving their returns, one in particular is growing in popularity.

A report, published by the Peer to Peer Finance Association (P2PFA), shows that Peer to Peer lending rose by a staggering 121% in 2013 with nearly a billion pounds invested.

So, if your have savings being eaten away by a combination of low interest rates and inflation, should you be tempted by Peer to Peer lending? What are the risks? How safe is it?

Read on for all the answers plus seven helpful tips.

First things first, what is Peer to Peer lending?

Peer to Peer websites match lenders and borrowers, who are either individuals or businesses. A lender will commit their capital, which will then be lent out to a large number of individuals or businesses.

The return you get is based on a number of factors, including the interest rate charged to borrowers, the fees you pay and the rate of defaults, when people or businesses fail to make repayments.

Interest is taxed at the same rates as a ‘traditional’ savings account, although it needs to be declared and paid through the Self-Assessment system.

Most Peer to Peer lenders offer a variety of terms from one to five year fixed rates.

Best buy savingsHow much better are the interest rates?

If you are prepared to tie up your savings in a three year fixed rate bond from a ‘traditional’ bank or building society, you are currently able to get a rate of 2.5% – 2.7%. For a five year fixed rate bond this increases to 3.2% – 3.25%.

Rates from Peer to Peer websites are certainly higher. For example Zopa currently quote a projected three year rate of 4% and 5.2% for five years; both are quoted after fees. Ratesetter quote higher rates of 4.8% and 6.1% over the same time periods.

Whilst the rates are certainly higher, Peer to Peer investors need to remember they are taking on a greater degree of risk.

What are the risks? How safe is it?

Whilst Peer to Peer lending is often marketed as an alternative to savings it carries a greater degree of risk.

Firstly, the return paid to investors is dependent on borrowers making their repayments. Each Peer to Peer lender manages this risk in a different way, but if defaults are higher than expected, your return will be less and your capital could be put at risk.

Secondly, the investment is not covered by the Financial Services Compensation Scheme (FSCS), if the company you use goes bust you could lose some or all of your capital.

7 tips for choosing the right Peer to Peer lender

  1. Make sure you know how quickly the Peer to Peer lender will actually lend your cash out. This isn’t always immediate and you may get a lower rate of interest, or even no interest, until your money is actually lent, this will of course have the effect of reducing your return
  2. Don’t blindly go with the best interest rate, consider other factors such as fees, how defaults are dealt with and what happens if you need early access to your cash
  3. Remember that as a rule of thumb the higher the rate of interest quoted the greater the potential risk that the borrower will default
  4. Compare the fees charged by the various Peer to Peer lenders, some charge you up front, others on an annual basis and some have other ad hoc fees. You also need to check whether the quotes returns are before or after fees
  5. Remember that if you are a saver using a Peer to Peer lender will turn you to an investor; you will be giving up much of the protection you enjoy as a saver
  6. Tax is paid on the gross return, you cannot offset fees or any defaults, so you could end up paying tax on interest you’ve not had!
  7. If you think Peer to Peer lending might be for you, but are nervous about committing a large sum to such a new way of investing, consider ‘dipping your toe’ a small amount, which wouldn’t significantly affect your finances if it were all lost

Should you be tempted?

The higher interest rates are of course tempting and if you can accept the potential downsides, including the fees, the lack of FSCS coverage and the potential losses, then Peer to Peer lending is worth investigating further.

But remember, it isn’t saving, it’s investing and you should be completely sure you can accept the potential downsides before you go ahead.

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