Ratesetter and Funding Circle lead the way in peer-to-peer lending
Since they first arrived on the scene six years ago, peer-to-peer lending companies have created a whole new lending world. There are now several players in the market, but the big three are Zopa, Funding Circle and RateSetter. These firms allow individuals, or small businesses, to borrow money from other individuals without the intervention of a bank.
For borrowers the service has become increasingly vital, as loans from traditional sources such as banks or building societies have dried up in the wake of the banking crisis.
People are able to borrow money at a much lower rate than they would find through traditional means – usually around 8% APR. In comparison, the best rate available from high street lenders is around 9%; but that is only available for people with squeaky-clean credit records – anyone else can expect a rate closer to 15% or 20%.
When he started shopping around for a personal loan to consolidate that debt he was quoted rates ranging from 18% to 24%; then he saw an advert for Zopa. He was given a rate of 13.9% including all fees, and was delighted with the service. "The best part of it was that I could overpay without penalty, so whenever I had a spare £20 I would log in to Zopa and pay off a bit more of my debt," he says.
As for lenders, if they are prepared to take the risk, they can see returns of around 8.3% over the period of the loan - which can be anything from one to five years, depending on which company you use.
Mark Barry-Jackson, 62, from Surrey has been very impressed by Funding Circle. "I put in £500 last November, but it wasn't long before I topped it up to £10,000 after receiving some money from a drawdown arrangement – having enjoyed an average gross yield of 9.4%."
Given that the best buy savings accounts offer less than 5%, that's a fantastic rate of return.
How to get started
To get started, borrowers set out their proposal stating how much money they need to raise (up to £15,000 with Zopa) and give some information so the firm can perform a credit check. Depending on the results of your credit check you will either be rejected or accepted and classified based on risk. This will also affect what interest rate you get.
Those deemed safest are rated A* and get the lowest interest rates. Lenders just have to state how much they are prepared to lend, and at what rate. Then the website matches lenders' money with suitable borrowers.
For borrowers it is important to note that in most cases peer-to-peer lenders aren't likely to lend to you if the banks have turned you down. They tend to be very selective, as they want to protect their lenders' money.
However, Yes-Secure, set up last year, aims to lend to people who struggle to get fi nance elsewhere. As a result its interest rates tend to be higher, typically starting at 13.25%.
The question for most lenders is how safe is their money?
If the person you've lent money to does a runner, will you be out of pocket? This varies with each company, but with the big players such as Zopa or Funding Circle, if a borrower defaults on payments a collection agency is brought in to chase them - just as with a high street bank. Moreover, lenders' money is split and lent to several borrowers in order to minimise the risk. The chances of a borrower defaulting are very low too – RateSetter states that all its lenders get their money back.
But what about if something goes wrong with the actual lending company? The Office of Fair Trading regulates all the firms, but lenders' money isn't covered under a compensation scheme, as ordinary bank deposits are. If the lending company was to go bust administrators would be required to ensure borrowers continued to repay their loans, but the exact details are unknown as a peer-to-peer lender has yet to go bust.
Zopa, Funding Circle and RateSetter are all well funded and have set up a self-regulatory body to maintain high standards across the industry.
So far the peer-to-peer formula is working. Zopa recently celebrated having loaned out £150 million. Giles Andrews, its chief executive, is the fi rst to admit that part of the reason for the low default rate is that the lenders are "incredibly selective" about who they lend to, but he also says that a human element plays a part: "We have evidence that people recognise that they are borrowing from real people so prioritise the repayments."
Peer-to-peer lending now makes up around 2% of the unsecured personal loan market, but it will be a while before the banks are worried about any competition.
"Social lending is a new and emergent sector of the lending market which we welcome and are watching with interest," says Nathan Hatch, a spokesperson for Lloyds Banking Group, but he adds that it isn't affecting the way Lloyds operates its loans department.
While the big banks remain reluctant to lend out money and savings rates remain low, peer-to-peer lenders are filling a vital role in the market.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
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.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.