Interest rates on traditional savings accounts are at record lows and even if you are prepared to tie your money up for five years you would struggle to earn 2%.

The poor returns have resulted in thousands of savers switching to peer-to-peer (P2P) lending as a more lucrative alternative.

P2P websites match investors with borrowers and provide a convenient platform that allows the two groups to agree lending arrangements.

This enables people with spare cash to lend their money to individuals or small businesses who want to borrow.

Spreading your risks

The loans can be divided between lots of different borrowers to reduce the risk of bad debts.

You can choose the length of time that you want to lend your money and the credit worthiness of the recipients. In return you are likely to get a higher rate of interest than on cash savings in the bank. Borrowers might also be better off as they could end up paying a lower rate of interest than on a bank loan.

The Peer-to-Peer Finance Association says nearly £3bn was lent via P2P platforms in 2016. UK platforms with the most amount of business in the year included Funding Circle, Zopa, RateSetter, LendInvest and Market Invoice.

How much can I make?

The largest P2P platform is Zopa, which lends exclusively to individuals and operates a provision fund to cover the likely level of bad debts.

Its estimated rates of return vary between 2.9% and 6.1% depending on how much risk you want to take, with investors able to withdraw the repayments whenever they want and to sell their loans early assuming that there is someone willing to take them on.

Other platforms offer some sort of security for the debt. For example, FundingSecure specialises in loans secured against the personal assets of the borrowers and says annual rates tend to be 12% to 13%.

IT IS POSSIBLE TO EARN
10%+ ANNUAL RETURN FROM P2P

There is also Lendinvest, which makes bridging loans and loans to finance the re-development of properties with the loans secured against the bricks and mortar. You can lend for anything from one month to three years with the expected net returns starting at 4% per year.

ArchOver says it offers lenders a ‘Secured & Insured’ investment opportunity, where the security is in the form of credit insurance over the accounts receivable. ‘We believe the security we provide is unparalleled within P2P business lending and is matched with a favourable return of up to 7% a year,’ says chief executive Angus Dent.

Funding Circle provides loans to small businesses and currently offers an estimated return of 6.8% per year after adjusting for the estimated level of bad debts. You can choose to whom you want to lend or use the Autobid feature to do it automatically. The latter divides your money between at least 100 different businesses to reduce the risk of default.

P2P INVESTMENT TRUSTS

IF YOU ARE not comfortable using the peer-to-peer platforms you could still benefit by buying one of the P2P investment trusts. There are half a dozen listed on the stock exchange including P2P Global Investments (P2P) and Funding Circle SME Income (FCIF) with most targeting yields in excess of 6%.

What if the borrower fails to repay?

Savers who put money into a cash deposit account are protected by the Financial Services Compensation Scheme (FSCS), but there is no such cover with P2P as it is more akin to an investment.

‘P2P isn’t covered by the FSCS, which means that if a borrower or provider defaults then investors could be left out of pocket,’ warns Patrick Connolly, a certified financial planner at independent financial adviser Chase de Vere.

The rates quoted by the various P2P platforms are the expected returns and are not guaranteed. These could turn out to be lower if the level of bad debts is higher than forecast.

Neil Faulkner, managing director of the P2P ratings agency 4thWay, says his company rates each of the platforms based on stress tests that see how well individual lenders might perform during a very severe recession. ‘The platforms with the highest ratings are Funding Circle, Landbay, Lending Works, Proplend, RateSetter and Zopa.’

He advises investors to check whether their P2P provider focuses on either very high quality borrowers or on fantastic security and that they are transparent about their statistics, particularly about bad debts.

The Financial Conduct Authority – the UK financial regulator – is currently carrying out a review of the P2P industry following high profile scandals in the US and China, and it is likely that this will result in greater regulatory scrutiny in the future.

Interest on P2P loans is paid gross but is taxable and has to be declared on your tax return unless you invest using an Innovative Finance ISA.

These allow you to pay in up to £15,240 in the current tax year – rising to £20,000 from 6 April 2017 – with many P2P platforms hoping to launch these accounts over the coming months. Landbay and Lending Works have already launched their Innovative Finance ISAs.

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