I'd use peer-to-peer lending to beat the banks

Hunting down attractive income in today’s low interest rate environment is akin to looking for a needle in a haystack.

Although a handful of banks and building societies have tickled up savings rates since the turn of the year, rates of 0.01% are still more common than those above 1%.

Without an increase in base rate, which admittedly could be on the cards sooner rather than later, savers must accept that income will remain scarce.

Even dividends from investing in stock-market listed companies are under pressure as corporate earnings are impacted by a weak pound.

For investors, this downward pressure on dividends can be mitigated by holding an investment trust with big reserves of income in its tank – income earned in previous years but not yet paid out to shareholders. By drawing on these reserves in the diffi cult years, some investment trusts have managed to increase their dividend payments for more than 30 consecutive years. Yet, impressive though such income records are, investment trusts are not for the risk averse.

One relatively new source of income for savers has come from the burgeoning ‘peer-to-peer’ (P2P) lending market, where institutions bring together savers and borrowers. In general terms, the money lent by savers is used to provide fi nance for expanding businesses.

 

The interest that the borrowers pay on their loans helps towards providing savers with an income on the money they have lent out. In terms of risk, it sits somewhere between the cast-iron guarantees that underpin deposit accounts (namely, security of capital and statutory protection up to £75,000 per financial firm from the Financial Services Compensation Scheme in the event of a bank’s collapse) and the volatility of shares. But in terms of income opportunity, it beats both deposits and shares.

 

This growing market, which is now regulated, is dominated by three players – Funding Circle, RateSetter and Zopa. The annual interest on offer varies, ranging from 2.9% (RateSetter) through to in excess of 7% (Funding Circle), but so does the degree of risk you will take.

While the 2.9% interest on offer from RateSetter comes with the backing of a ‘provision fund’ (designed to protect your capital from losses if loans turn bad), the 7% from Funding Circle has no such underpin. If a loan goes bad, your capital could be compromised.

Four and a half years ago, when peer-to-peer lending was beginning to grab savers’ attention, I decided to test it out. I invested £200 through Funding Circle. I feared the worst – as befi ts a cynical journalist – but I have been pleasantly surprised. My latest statement
informs me that my £200 has grown to £257.56. The £57.56 of added value comprises £82.89 of income, denuded by £9.41 of (Funding Circle) fees and £15.92 of losses.

All in all, it’s an annual return (after fees but before tax) equivalent to a shade above 6%. That’s far better than I would have done if I had put my money in a deposit account, but not as sexy a return as I could have got in an investment trust investing in the UK stock market. For example, if I had put my £200 in The City of London Investment Trust, a member of Moneywise’s First 50 Funds, it would now be worth £340.

 

My peer-to-peer money is spread across 16 businesses operating in everything from retail through to IT. It is effectively an investment play on UK plc. When the economy is strong, my companies are more than likely to keep repaying the loans they have secured.

As someone who is still working and not in need of savings income, I will not be committing more funds to Funding Circle. But if I were looking for alternatives to cash, peer-to-peer is certainly an option I would consider.

Especially when the big three get regulatory clearance to launch innovative fi nance Isas (peer-to-peer individual savings accounts) in the spring, then enabling all returns to be tax-free. Of course, as with any fi nancial product, you need to ensure that you end up with the right lender (stick to the big three). You must also understand the risks and all the fees involved. But mark my words, peer-to-peer lending is here to stay.