Ditch the banks and join the social lending crowd
Sick of the banks, their paltry savings rates and tight-fisted attitudes to lending? Well, join the growing club - or rather, crowd of consumers turning to the expanding breed of internet-based services that aim to give lenders and borrowers a better deal through so-called crowdfunding.
By cutting out the middlemen with their expensive workforces, bonuses and branch networks, these operations pair up savers with borrowers online in peer-to-peer (P2P) or social lending arrangements that aim to give 'savers' - who are actually lenders - a higher return on their money. In fact, interest rates currently on offer range between 6 and 8% before tax, outclassing those on most conventional savings accounts, where the top rates for a cash ISA are hovering around 2.5%.
Depending on which P2P service they choose, savers receive returns either in the form of interest or potential equity returns when they're lending to businesses.
Interest in the sector is growing steadily, with the UK P2P market heading for £500 million worth of lending this year. It was pioneered by Zopa eight years ago as the first online agency for individual borrowers and lenders who agree their own rates between them. "We are a marketplace, not a bank," it insists.
Although the market is still of minnow proportions, it has now expanded to include players such as RateSetter, offering similar consumer credit arrangements to Zopa, and the likes of Funding Circle, Squirrl.com, Seedrs and Crowdcube, all specialising in lending to cash-starved businesses. In the next couple of months, Zopa will also start offering loans to the UK's 3.5 million sole traders, thanks to a £10 million injection from the government Business Finance Partnership package.
Average loan size at the consumer-focused operations is £5,000, with the majority of lenders being male Middle Englanders, aged 45 to 50-plus. The typical borrower is also a Middle Englander, taking an average loan of £5,000 over three years, who wants the cash to make large domestic purchases such as a new kitchen or car, according to their loan-profile information.
Funding Circle's loans, which are for businesses, average around £65,000, but the profile of the average lender is also about 50-plus, who invests £5,000. James Meekings, co-founder of the company, says: "They tend to be people heading towards retirement who are feeling let down, not just by savings rates but by the volatility of other investments, and need an income from them."
No high exit penalties
Lenders aren't just attracted by rates. Another advantage is loans can be sold on to other lenders before their term has ended without the high exit penalties associated with some fixed-term savings accounts. Meekings admits there's no guarantee loans will be sold on and they could be sold at a loss. However, the process can be quick. "My fellow director got all his money out in two hours recently when he needed it to buy an engagement ring for his fiancée," he says. At Zopa, there's a charge of 1% of the original loan for those cashing in immediately (unless the borrower has defaulted).
Although the terms P2P and crowdfunding are often used interchangeably, the latter tends to describe online equity investment platforms, an area that attracts wealthier investors.
Luke Lang, co-founder of Crowdcube, which acts as an online introduction agency for businesses that pitch online to its register of 31,000 investors, says: "We differ in that debt finance services tend to lend money that is repaid within three years. With us, it's equity and the investor has a legal standing and gets a share certificate. Any payback is further down the line. It could be in three, five or eight years' time before the business is ready to exit or sell. The absolute risk is they might not get anything back but there is the potential of high returns."
Although the risk of P2P lending is relatively low, a significant drawback for savers/would-be lenders currently is most of the P2P organisations cannot be part of the Financial Services Compensation Scheme (FSCS), which steps in to rescue savers with conventional bank accounts by up to £85,000 if their provider goes bust.
Regulating loan-based services
However, plans are afoot for the Financial Conduct Authority (FCA, formerly the Financial Services Authority) to at least regulate the loan-based operations from April 2014, while equity-based services are already regulated, and in some circumstances may offer compensation through the FSCS if an investee company goes bust.
Recognising such security concerns, the three biggest players - Zopa, Funding Circle and RateSetter - set up the P2P Finance Association to lay down high minimum standards of unofficial protection, which range from spreading your savings around numerous borrowers to setting up a fund designed to cover any losses (see table). And Zopa has just introduced a safeguard that pledges to make up all money owed to a lender, including the interest, in the event of the borrower defaulting.
However, one threat to the market is that rate hunters could desert social lenders in droves when bank interest rates rise. But Meekings believes the P2P model will still be attractive.
Alex Gowar, marketing director of RateSetter, adds that the sector has time to build up credibility. He says: "We operate as if we are regulated already. Our provision fund is paid for by a small payment from every borrower." So far, no one has lost any money, but Gowar concedes a worse-case scenario of when the "pot could run dry".
Strict credit checking is key, he says, and as a result bad debt rates at RateSetter run at an average of 0.34% , compared with the banking average of 3 to 5%. Gowar says: "Banks charge higher APRs on the loans as a result. We see ourselves as a risk management company. It is in our interests to be strict as to who we allow to borrow. Only about 12% of those who apply are approved."
P2P is a long way yet from being a mainstream threat to the banks. To put it into context, the lending of Funding Circle, RateSetter and Zopa amounted to £250 millon last year, while the main banks lent £75 billion to businesses. However, Liam Collins, policy adviser at Nesta, a charitable organisation that monitors the P2P market, believes the sector will thrive and its research suggests it could account for as much as £7.5 billion, or 10%, of business lending within five years.
Elements of P2P, such as giving investors a clearer view of where their savings are invested, might appeal to their rivals, the banks. However, it's more likely the banks will be content to just let P2Ps go on eating the crumbs from their collective table, just so long as they don't get too hungry. As Anderson, says: "We do a lot of what the banks do, apart from manufacturing money. The banks are good at that and will continue to be good at it. But we're good at fixed-term instalment loans and we will continue to take this narrow niche."
Stephen Burnett, 58, from Stamford in Lincolnshire, is a fan of social lending after getting the cold shoulder two years ago from three banks when he needed a loan to grow his profitable point-of-sale equipment business The Retail Data Partnership. He says: "We'd signed a deal with cash-and-carry giant Booker and I needed a loan to help meet the increase in demand.
"My own bank, Lloyds TSB, told me I'd be turned down due to the level of retained losses on the balance sheet. I talked to Barclays and Triodos, which both said the same, so I went to Funding Circle instead. It took me 90 minutes to complete the application and it came back within a few days giving us an A risk grade, meaning we looked like a good borrower. Within 12 days, I had raised the £65,000, to be repaid over three years in equal monthly instalments." With the money put to work, the business is "storming ahead", he says, increasing its customer base almost threefold and staff numbers from 16 to 28.
The name given to a certain type of financial transaction which takes place directly between individuals or “peers” without the use of a traditional financial institution such as a bank. Various social lending websites incorporate a number of strong risk controls, and screen all potential borrowers by checking their credit history. Lenders agree to lend a specific amount for a stated return and lenders’ cash is pooled between borrowers, spreading the risk. The major social lending companies are Zopa, RateSetter, Funding Circle, Quakle and Yes-Secure.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).