Can social lending make you money?
Q: I have some money to spare and am intrigued by the idea of social lending through sites such as Zopa. I was wondering what the risks and returns are like and if it's worth it?
I know Zopa categorises potential borrowers based on their credit histories and then lenders set the rates they wish to receive.
The potential returns of lending this way would be much greater than what my savings account currently pays in interest – even though it does mean investing for a minimum of three years.
I don't want the risk of a shares portfolio and so I think this might suit me better. But I don't know how to gauge the possibility of bad debt and any charges that may come about.
To begin with, I think I would only lend to one of the top two categories. Any help or clarity on the matter would be much appreciated.
A: Justin Modray is a former IFA and founder of candidmoney.com
Social lending is a clever idea and the potential returns look attractive for lenders in the current low interest-rate climate.
But you need to be aware that if borrowers fail to repay you, you'll lose out. And this, along with Zopa's annual 1% fee, will reduce your annual return.
The risk of bad debt is reduced by Zopa splitting your money between at least 50 borrowers, and you can obviously choose to lend to those at the safer end of the creditworthiness scale.
Once your money is lent out you'll receive monthly repayments, unless the borrower defaults, in which case Zopa will chase the money, using a collection agency if necessary. But there's no guarantee it will recover it.
At present, annual returns for lenders, after Zopa's fee and estimated bad debt is accounted for, are around 5-6%, which compares well with savings accounts.
But the interest is paid gross and is taxable, and bad debts unfortunately can't be offset to reduce tax, diminishing the appeal for higher-rate taxpayers.
Also bear in mind we're in a period of challenging economic times, and as further tax rises and spending cuts are likely to take their toll, there's a risk that bad debts will increase.
All in all, lending via Zopa or the social lending newcomer YES-secure is a bit like using a fixed interest savings account, except your return could be affected by bad debts, which are not covered by the Financial Services Compensation Scheme.
Compare the potential returns to best-buy fixed rate savings accounts, then decide whether the extra return is worth the added risk.
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.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.