With public trust in banks still dwindling, a new personal way of earning interest by lending money directly to other people is flourishing. But is `social lending' really a practical alternative to traditional banking?
A new set of peer-to-peer (P2P) or social lending websites have risen from the ashes of the recession and capitalised on the contempt that many of us now have for our banks. Essentially P2P lending sites cut out the financial middle-man and allow you to lend directly to other individuals or businesses. You choose how much you want to lend, who you want to lend to and how much interest they should pay.
But there are still important differences between the key players in this new social lending market – so let’s take a closer look at each site...
Zopa
Launched: March 2005
Amount lent to date: £125m
Lender fees: 1% of the amount lent
Average return: 8.6% over the last year (7.6% after fees but before bad debt)
Zopa is the big fish in the P2P pond and now makes up 2% of the unsecured personal loan market in the UK.
The site allows you choose the type of borrower you want to lend to, the level of risk you are prepared to take on and the interest rate you wish to receive. Your money is then lent out to several different credit checked borrowers to reduce the impact of any defaults. When a repayment is made by the borrower each month you receive a slice of your capital investment back, along with some interest.
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Zopa will also chase up any overdue payments using a debt collection agency or the courts if necessary. But despite these precautions, defaults do occasionally occur and can eat into profits.
Lenders can withdraw any remaining invested funds at any time by transferring the amount of unpaid debt to another user, subject to a 1% admin fee.
Zopa also runs a listing service that allows lenders to obtain more information about the individual borrowers and make manual loans of single amounts to whoever they wish to lend to.
Funding Circle
Launched: October 2010
Amount lent to date: £8m
Default rate: None so far (expected: 0.6% - 2.3% depending on risk)
Lender fees: 1% of monthly borrower repayments
Average return: 8.3% (7.3% after fees but before bad debt)
Funding Circle uses a similar model to Zopa with the key difference that you are lending your cash out to small businesses and not individuals.
All borrower companies are identity, fraud and credit checked by the site and must have at least two years of audited accounts to be eligible for a loan. The business set up a loan request indicating their target interest rate and lenders are invited to offer up their cash, specifying what rate they wish to receive. After bidding on the request has ended the lenders with the lowest interest rates will all take a stake in the loan.
The key attraction of Funding Circle is that you can view the type of business that your cash will go to, inspect their accounts and ask questions about what your money will be used for. An automatic lending tool is also available if you don’t fancy lending out your cash manually and like Zopa, Funding Circle will chase up any missed payments using a debt collection agency.
Ratesetter
Launched: October 2010
Amount lent to date: £2,625,892
Default rate: None so far (anticipated: lower than 1.4%)
Lender fees: 10% of interest received
Average return: 3.8% - monthly access, 7.9% - 3 year fixed (after fees and bad debt)
Ratesetter is a far more anonymous service than Zopa or Funding Circle. As a lender, you simply transfer in your funds and set the interest rate you want. Your request is then matched with a borrower who wants to pay the same interest rate on a loan.
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If your requested interest rate is too high and does not match with any loan requests then you can either lower your rate or be put in a first-come first-served queue until the higher interest rate becomes available.
Unlike Zopa and Funding Circle, if you lend out money on Ratesetter it will go to one single anonymous borrower. Because of this, Ratesetter have a provisional fund that borrowers pay into according to their credit-rating. This fund currently stands at £173,712 (around six times the anticipated amount of bad debt) and is designed to reimburse lenders in the event of any bad debt.
Ratesetter allows you to lend money out on a rolling monthly basis, where the interest rate will vary each month or lock up your cash for three years at a fixed rate.
YES-secure
Launched: June 2010
Amount lent to date: Around £200,000
Default rate: None so far (expected: 3-12% depending on risk)
Lender fees: 0.9% of monthly borrower repayments
Average return: Advertised rates range from 9% - 35% (before fees and bad debt)
Quakle
Launched: October 2010
Amount lent to date: Around £18,000
Default rate: None so far (expected: 1%-3%)
Lender fees: Free
Average return: 20%+ (before bad debt)
I’ve grouped YES-secure and Quakle together because they are both much more on the social side of social lending. Both sites essentially act as a listing service where borrowers create loan adverts with details of their personal situation and why they need money. Both sites also credit check all their borrowers and attach this rating to each advert pitched.
You can review borrower profiles, make enquiries, consult reviews of the borrower and view their lending history before deciding whether to pledge an amount to the loan.
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Where next for P2P?
Personally I believe P2P lending sites are a welcome move away from the faceless nature of modern banking. But for this new sector to really achieve mainstream appeal, they’ll have to win over the bulk of the public who still simply distrust the idea of lending money to a total stranger.
Zopa have begun to do this through their rigorous credit checking and conservative lending practices. Yet the lack of regulation in the sector is a major turn off for a lot of people. Social lending sites are not registered with FSA and the deposits of lenders are not covered by the FSCS compensation scheme designed to protect against bankruptcy and default.
Most social lending sites have measures in place to ensure that you will get your money back if they go bust and stress the fact that the actual loan contract is between you and the borrower – the site is just the facilitator.
But P2P lending sites still urgently need the air of credibility that an authorised regulator can bring to a sector.
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