Peer to peer lending: what you need to know

Peer-to-peer lending (P2P) is a way for people to lend money to individuals or businesses. You - as the lender - receive interest and you get your money back when the loan is repaid. But P2P lending can be much riskier than a savings account.

What is peer to peer lending?

You can find out more about peer to peer lending, including costs and processes, in Peer to peer lending.

P2P websites work like marketplaces.

They bring together people or businesses that want to lend money with those that want a loan.

It’s a way for borrowers to get funding without going to the banks.

On some websites, any money you lend out is automatically divided between lots of borrowers, but with others, you can choose who you’d like to lend your money to.

Generally speaking, the higher the interest rate someone will pay, the riskier they are likely to be.

Getting started with peer to peer lending

There are three main steps:

If you want to lend money, you should first compare P2P lenders and find one you feel comfortable with.

  1. Open an account with a P2P lender and pay some money in by debit card or direct transfer.
  2. Set the interest rate you’d like to receive or agree a rate that’s on offer.
  3. Lend an amount of money for a fixed period of time – for example, three or five years. You might have to pay a fee to lend money (i.e. 1% of the loan).

Some lenders have an ‘autobid’ feature.

This means you can set limits on how much you want to lend each business and the lowest interest rate you’re prepared to lend at.

Understanding the risks

P2P lending can be risky for several reasons.

It’s useful to understand these risks and how they can be reduced.

The risk of default

The person or business you lend money to might not be able to pay it back (called ‘defaulting’).

The higher the default rate on a P2P website, the higher the number of people or businesses that are unable to repay their loans.

Unlike bank and building society savings, the money you lend via a P2P website is not covered by the Financial Services Compensation Scheme.

However, a number of P2P websites have contingency or provision funds, which are designed to pay out if a borrower defaults on their loan.

These provision funds vary widely from one site to another, so make sure you know what’s covered if you’re thinking of becoming a lender.

The risk of early or late repayment

If your loan is repaid early or late, you could make less profit than you’d expected.

If a loan is repaid early, you can simply lend out the money again.

But there is a chance that you might not be able to lend out at the same interest rate.

The risk of the P2P site going bust

You could lose money if the P2P company itself goes out of business (several have).

However, if they are regulated by the Financial Conduct Authority (as all P2P lenders operating in the UK must be), they must keep lenders’ money in ring-fenced accounts separate from their own.

P2P lending and tax

The interest you earn from P2P lending is taxable, but it is normally paid without tax being taken off.

That means if you are a taxpayer, you have to tell HM Revenue and Customs about the interest you’ve received.

You have to pay tax on all the interest you should have received, even if you don’t get the full amount because of defaults.

You can get an Innovative Finance ISA which allows P2P loans to be held in an individual savings account (ISA). This means you can receive the interest from P2P loans without paying tax.

Organisations that can help

Before you lend through a P2P lender you should check that:

  • it’s regulated by the Financial Conduct Authority. You can do this by searching for it on the FCA Register; and
  • it’s a member of the P2P Finance Association. Its members must abide by certain rules and must have been trading for at least six months.
If you have a complaint about a P2P lender that they cannot resolve, you can complain to the Financial Ombudsman Service.

Did you find this guide helpful?